In the first ten months of 2023, many traders rightly suspected the AI-powered surge in tech stocks of resembling a bubble due to burst. “There’s disbelief that the tech rally can last after a huge run”, said Todd Sohn of Strategas Securities in June. There was plenty of reason to believe the US Federal Reserve would remain in a hawkish mood for some time. Add to this the fact that the battle in Ukraine continued to rage, keeping global markets on edge, and the reality that China’s slow growth did not bode well for the world economy. As a result of all this, emerging-market stocks (which generally light up on the radars of growth investors), were sold off in large amounts – amounts worth $2.6 trillion.

The economic environment described above illustrates the sorts of forces that make the stock trading mood more risk-averse. When this happens, traders tend to favor stocks that have been around longer than most because their chances of staying in business seem higher. These stocks, called value stocks, need not necessarily be oriented toward rapid growth in the way tech stocks are. What makes them appealing is their appearance of sturdiness in an economic world that looks likely to blow over companies with shallow roots.

We see, then, that economies suffering through bear markets or recession worries tend to foster value stocks. Bull markets, on the other hand, favor growth stocks because people feel, in such times, that outsized earnings are there for the taking. But what are some other differences between growth investing and value investing? And how can it be true that, despite the investor caution that characterized most of 2023, the tech rally did keep going?

Dividends and P/E Ratios

Growth investors have their eyes fixed on the earnings they could make when they eventually buy their stocks. They believe the young companies in which they invest will see rapid growth, rising earnings, and climbing stock prices, and that this will position them to sell their shares at a much higher price than that at which they bought them. Such companies might, therefore, have generated very little, if any, earnings at the time they’re snapped up. As a result, they will exhibit high price-to-earnings (P/E) ratios, which means the price of the stock is high to the company’s earnings-per-share (EPS). When you see a company has a high P/E ratio, it either means the stock is overvalued or that traders believe strongly in its future growth potential.

Growth investors don’t care about overpaying for the stock because what they’re pinning their hopes on is the prospect of the company in question achieving industry dominance, which will elevate the value of their investment many times over. The basis for this hope could be, for instance, that the company possesses a new sort of technology that promises to take the market by storm. Or perhaps they hold a patent that could give them an edge over the competition.

By contrast, value investors aren’t expecting their companies to change the market scenery. Rather, their humble condition is that the stock be trading at a lower price than it’s intrinsically worth. Such a company need neither be new nor an industry disrupter. The point is that, over time, the stock will actualize its real value and their investment will appreciate. In the meantime, they’re happy to receive dividends on their investments, which keep a steady flow of income coming in. Growth investors give up on receiving dividends to allow their companies to re-invest their earnings in continued growth.

A Tech Rally in 2023?

The most salient qualities of the economic environment in 2023 were high-interest rates, slow growth, and high inflation. This didn’t look very good for growth stocks. The AI companies driving the rally tend to borrow lots of money to maintain their product development, and this makes interest rate hikes particularly unpalatable for them. Yet the fact remains that tech stocks enjoyed an extended time in the sun, outdoing the S&P 500. This was surprising to many and shows that the rules are not set in stone.

The anxiousness not to miss out on the burgeoning technology of AI overwhelmed many traders’ senses of prudence. Health technology companies were also big success stories in 2023. Promises of breakthrough medicines with official approval were enough to keep these shares flourishing in stock trading action. Many traders showed themselves willing to compromise the relative safety of the value investing approach for the sake of potentially large payouts.

The Terrain Ahead

As we mentioned, though, the overall trend until November was in favor of value. One of the factors that helped drive this trend, besides those we’ve mentioned, was a hike in oil prices. This pushed up the prices of energy stocks, which are on the value side of things.

However, “value could underperform growth in the fourth quarter” of 2023, says Malcolm Dorson of Global X Management Co., and the reason is that the Fed has sounded dovish lately. Fund managers have been buying EV and e-commerce stocks with elevated valuations because of a shift in sentiment toward risk-taking. Watch out, though, for interest rates that stay higher for longer and for signs of a recession, because these two things could change the scenario very quickly.

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