Traders like to consider themselves independent thinkers on the investment landscape, but when the shape of the investment landscape is defined by the collective actions of others, you have to run with the herd. Also known as trend-following, this has been an accepted part of futures trading for years.
Equity traders and investors have to play the game a little bit differently, as most institutional investors have to follow charters defining their risk parameters and industry exposure. If you look at the prospectus for something with “value” in its name, you should not have to guess whether or not the manager favors stocks with low price-to-book ratios and above-average dividend yields.
While these investment managers have to hew to their charters, plus or minus, their investors do not. As various types of investments move into and out of favor, flows of funds follow in long-running trends. Sometimes these propel growth stocks in a given sector higher, as happened during the technology bubble of the late 1990s; sometimes they push the value stocks in a given sector lower, as happened to the large-capitalization financial stocks during the 2008 financial crisis and its aftermath. In all cases, these changing investment fashions are reflected in the divergent behavior of style indexes, such as the Russell 1000 Value and Russell Growth indexes.
Let’s look at how “value” vs. “growth” investment trends have moved over time for these large-capitalization issues, what their economic sector dependencies have been and how you can use some readily available market indicators to trade futures on them.
Value and growth differ from each other on more attributes than price-to-book and dividend yield, they also have profound differences in their sector exposure. The largest sector exposure in the value index, by far, is financial services. The other three sectors where value outweighs growth are energy, utilities and health care. Two of these sectors, financial services and utilities, will be singled out for factor analysis in “Comparative sector weights” (below).
The two sectors with the largest relative weights in the growth index are consumer discretionary and technology. Neither should be surprising given their respective leverages to consumer and business spending. Both of these sectors have high volatility levels and tend to surrender gains quickly during market downturns.
In homage to the old Wall Street adage, “It is a market of stocks, not a stock market,” we can say, “It is a set of sectors, not just a single value or growth index.”