2Q 2021 GMO Quarterly Letter


Executive Summary

After several strong quarters for value stocks, the last few months have seen a sharp reversal in favor of growth. Understandably, this has led some investors to question whether value’s run is over and whether value investing makes sense as anything more than a tactical play. While the brevity of value’s resurgence has been frustrating, it does provide me with an excellent opportunity to address some of the objections I hear from investors who are hesitant to join us in betting strongly on value today. Our conclusion remains that this is the most compelling opportunity we have seen for asset allocation alpha since the 1999-2000 internet bubble.

After two of the best quarters for value in at least a decade, the second quarter of 2021 saw a return of growth stock leadership and that move continued into July. The reversal actually started close to the end of the second quarter. As of June 3, the Russell 1000 Value index was 1.6% ahead of the Russell 1000 Growth index for the quarter. The rest of June through the end of July saw growth rise by 11% and value fall by 0.7%. It was frankly enough to trigger nightmares for a value manager.

But while this was certainly a disappointment for those of us positioned to benefit from a resurgence in cheaper stocks around the world, it did not come as a particular surprise. Habits once formed can be hard to break, and investors have had at least a decade to develop the habit of turning to U.S. large cap growth stocks amid feelings of rising uncertainty. There were similar moves in the two greatest periods of outperformance of value in my lifetime, 1973-77 and 2000-02. In the first period, U.S. large cap value ultimately outperformed U.S. large cap growth by 94% and in the second, U.S. large value outperformed growth by 114%. But within those astonishingly pro-value periods exist some of the best months for growth relative to value on record. In fact, 6 of the best 10 months for U.S. growth versus value in the period from 1971-2019 occurred in those two periods, which made up only about 13% of the total months.1 This pattern of great growth months in great value runs can be seen in Exhibit 1.


Source: Russell Investments, GMO, Compustat. From 1980-2019 performance is for Russell 1000 Value less Russell 1000 Growth. From 1971-79 performance is for cheapest 50% of price/book versus most expensive 50% of price/book in Top 1000 U.S. stocks.

But even if sharp reversals are a common occurrence during value runs, they also predictably bring out the arguments as to why the period of value outperformance was the anomaly and this is merely a return to the “normal” pattern of growth winning. As we have been getting plenty of such arguments and questions, it seems worthwhile going through a few of them here.