The Value Comeback Came and Went

It lasted five days, and there's no word on when it will return.
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If you blinked, you missed the much-heralded comeback of value investing. Indeed, the ink was barely dry on news reports that bargain-basement stock-buying was back in vogue when the strategy again fell flat.

Last week, the

S&P 500 BARRA Growth

index, which tracks performance of growth stocks within the

S&P 500

, began to lose ground to its value counterpart, the

S&P 500 BARRA Value

index. The move reversed an 18-month trend in which growth stocks significantly outperformed value stocks.

The growth slide, which began April 13, resulted in a five-day return of negative 10.2% on the growth index and a positive 0.9% return on the value benchmark. It was the first glimmer of hope for long-suffering value funds, whose beleaguered managers were quick to embrace the notion that their time had finally come.

But not everyone was convinced that a week's move marked a new trend. "At a conference last week, I found it funny how many said value was coming back," says Gus Sauter, manager of the

Vanguard Group's

25 indexed portfolios. "There has been no economic catalyst to shift the trend. I thought it was a hiccup."

It was.

After Monday's technology selloff, growth again took the lead. The growth index has tacked on 8.8% since Monday's market close, while the value index has added an anemic 1.6% through Thursday.

"It is extraordinarily difficult to call the turn in value vs. growth," says Sauter.

Yes, value stocks "look like a tremendous buy from a relative standpoint," he says. "But stocks can be undervalued, and the market doesn't have to swing in their favor." The small-cap sector is a good example, he says. "We started seeing small-caps undervalued two years ago."

Historically, growth and value have moved in three- to four-year cycles of market leadership, with value tending to outpace growth on the heels of economic recession. Following a boom for value stocks in the early part of the decade, growth has been the leader ever since. Indeed, value stocks have not finished a calendar year ahead of their growth counterparts since 1993. In the past 15 years through Thursday, the S&P BARRA Growth index has soared 1,009% while the value benchmark has moved up 554%.

The indices track large-cap growth and value by dividing up the stocks in the S&P 500 twice a year using a proprietary model developed by the analysts at BARRA, a Berkeley, Calif.-based investment consultant and money manager.

The model ranks the book-to-price ratio of each of the S&P 500's stocks. The stocks on the higher end of the book-to-price scale carry the potential for the greatest value because they offer the most bang for your investment buck. These "value" stocks are allocated to the value index until the market capitalization of the index is equal to half the market cap of the S&P 500. The rest of the stocks go into the growth index. So, while the number of stocks in each index varies, the market capitalization of each is the same. Currently, the value index comprises 378 stocks, while growth holds only 122. The indexes are rebalanced twice yearly.

At Vanguard, Sauter oversees portfolios that are designed to mimic the performance of each of the S&P BARRA 500 indices. Not surprisingly, the

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Vanguard Growth Index portfolio has attracted a lot of investor cash in recent years as large-cap growth stocks have led the portfolio to even greater heights than its parent fund, the $88 billion

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Vanguard 500 Index. The growth fund has close to $11 billion while the

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Vanguard Value Index fund has only $3 billion. That was not always the case. Until March 1997, the Value fund held more cash than the Growth fund.

The Growth fund's happy shareholders aside, Sauter finds this tendency for investors to follow performance somewhat disturbing. Even though he says he sees no fundamental change in the economy to support last week's reversal, the manager still doesn't discount the possibility that one could occur in the absence of an economic catalyst. "Reversion to the mean is a very strong phenomenon in the stock market," he says.

And since "we typically don't know the tide has turned until after the fact," Sauter recommends that investors avoid getting whipsawed by minute-to-minute predictions and invest in both growth and value.