A Deep Dive into the US Stock Market Performance
Updated: May 24, 2021
How company size and valuation characteristics affect returns
The Dow Jones Industrial Average (DJIA) is the constant barometer that news outlets use to describe how the US stock market is performing. While it is the most recognized, the DJIA only represents 30 large companies listed in the US. In comparison, more broader indexes like the S&P500 (500 biggest companies in the US) and Russell 3000 (3000 biggest companies in the US) are much better indicators of how the US stock market is performing. While the US stock market has recovered from the pandemic crash in March 2020, various types of companies have fared better than others. Below is a comparison of several different types of companies and their performance characteristics.
Large Companies vs. Small Companies
Over the last 40 years, both large US companies (S&P 500) and small US companies (Russell 2000) have had similar performance as seen in the chart below (Periodic data from Dimensional Fund Advisors from 1/1/1979 to 12/31/2020):
Over the long run, these types of stocks have showed comparable returns, but quarterly returns show a different picture. The following graph (using returns of S&P 500 index vs. returns of the Russell 2000 index) shows the difference in quarterly returns between large and small US companies. In this graph, a positive figure on the Y-axis represents large company outperformance while a negative result is indicative of small company outperformance. As can be seen in the quarterly results, large and small companies have behaved much differently. These differences add to a portfolio’s diversification and is reflective of why we hold both large and small companies in our portfolios. Of significant note is that this most recent quarter, small companies outperformed large companies by 19%, the greatest in any quarter over the last 40 years.
Value Companies vs. Growth Companies
Another way to divide the US stock market is by a company’s valuation characteristics. Companies that are considered “value” have a relatively low Price-to-Earnings (P/E) or Price-to-Book (P/B) ratios. Relative to the overall market, these stocks appear to be undervalued. For example, Johnson and Johnson (JNJ) is a stock that would be considered a value company as its forward P/E ratio and P/B ratio on 1/29/2021 was 17X and 6.6X, respectively. In comparison, growth stocks have opposite characteristics (high P/E and P/B ratios) and appear expensive relative to the overall market. Tesla (TSLA) is a stock that would be considered a growth company and had a forward P/E ratio and P/B ratio of 200X and 46.9X on 1/29/2021 (source: Yahoo Finance). These ratios depict how much the stock costs for each dollar of forward earnings or book value they have.
Over the last 40 years, value companies and growth companies have shown similar performance as can been seen in following Periodic Performance table. However, when we look over an even longer period of time, dating back to 1928, Value companies have outperformed Growth companies by 4.54% annually (Dimensional Fund Advisors recent article – “When It’s Value vs. Growth - History Is on Value’s Side”).
Over the last 40 years, both US growth companies (Russell 3000 Growth Index) and US value companies (Russell 3000 Value Index) have had similar performance as seen in the chart below (Periodic data from Dimensional Fund Advisors from 1/1/1979 to 12/31/2020):
Although long-term results of Value and Growth stocks are similar, much like the Large vs. Small Company example given previously, quarterly returns can differ greatly. The graph below (using Russell 3000 Growth Index returns and Russell 3000 Value index returns) shows the quarterly difference between Value and Growth company performance with a positive figure when Value companies outperform Growth. Of significant note is that this most recent year, Growth companies outperformed Value companies by 35%, one of the biggest differences annually since 1999-2001 technology bubble.
Another way this to illustrate changes in Growth and Value companies is by comparing their valuations (Price-to-Book Ratio) by the historical P/B ratio averages for their category. The following graph shows historical data dating back to 1926 to show the P/B ratios over time in comparison to the category average. Of significant note in this chart is that Value company P/B ratios have held close to the long-term average where Growth companies have been trading significantly above the category long-term average and similar to where Growth stocks were in the 1999-2001 technology bubble. (This graph is from the Dimensional Fund Advisor’s recent article: “Spread the Word: What’s New with Valuation Ratios”)
Large/Small and Growth/Value in Client Portfolios
In all client portfolios at BPC Advisors, we have a consistent holding allocation in the broad market category of US equities, however some portfolios have slightly more or less small company stock exposure because of legacy positions. In normal quarters, this is noise and does not show up significantly on performance reporting relatively to our benchmarks. In 2020, the historic difference between large/small and growth/value company stock performance can be seen in the portfolio returns. Overtime, we expect these figures to level out to long-term averages as long as we consistently maintain the large/small and growth/value portfolio characteristics.
US Equity Exposure Going Forward
If there is a single takeaway from the previous few pages and figures, it is that the US stock market is quite diverse and in the short-term performs in a diverse way. This is the exact reason why we hold all US companies, both large and small, growth and value. We expect the diversification to lower the overall portfolio volatility over time.
And next time the news is touting the Dow Jones Industrial Average gains or losses, we recommend looking beyond the heading at the broader market using the S&P 500 or Russell 3000 indexes.