It may not be time just yet for that rotation from growth stocks to value that many are calling for

  • Some say change is due after the S&P 500 Growth ETF, the IVW, has beaten the Invesco S&P 500 Pure Value (RPV) by 36 percentage points over the past five years.
  • But major shifts in style regimes (like from growth stocks to value shares) usually happen during tough market setbacks.
  • And the momentum stock leaders late in a bull market tend to lead into its end.
Traders work on the floor at the opening bell of the Dow Industrial Average at the New York Stock Exchange on September 28, 2018 in New York.
Bryan R. Smith | AFP | Getty Images
Traders work on the floor at the opening bell of the Dow Industrial Average at the New York Stock Exchange on September 28, 2018 in New York.

The idea of investing with a keen focus on value sounds sensible — virtuous, even. Who doesn't want to be smart about the price paid for stocks relative to companies' true worth?

For months, investors have pressed the case that stock market leadership should be passing from excellent-but-expensive growth stocks to cheaper value stocks more tied to a strong U.S. economy — while also predicting the overall market indexes will continue to edge higher.

In practice, though, any lasting renaissance for true value stocks would likely involve a period of tougher overall market performance for a good while longer. Major shifts in style regimes usually happen in the crucible of a market setback, and growth stocks simply represent too much of the market to retreat quietly while value moves to the fore.

And the psychological barriers to investors collectively embracing genuinely cheap, neglected stocks should not be overlooked: Owning the cheapest stuff means buying companies that appear not just boring but broken — terminally "disrupted" by technological change.

Let's say an an investor took a look at this chart of the S&P 500 Growth ETF, the IVW, dusting the Invesco S&P 500 Pure Value (RPV) by 36 percentage points over the past five years and decided it was time to bet that the laggard and leader will swap places.

Mean-reversion does happen over long periods of time, for sure. And owning cheap stocks always means betting in disliked, struggling companies. But beyond a sense that "Value is due to make a run here," it's unclear the market and economy are in a spot where a revival is necessarily imminent.

The S&P 500 Pure Value Index is a decent proxy for the pool of larger stocks where one would fish for beneficiaries of a value resurgence. It collects the stocks in the S&P trading at the cheapest statistical levels based on price-to-book, price-to-earnings and price-to-sales ratios.

Gap, Exxon and Xerox

So what would a devotee of value own in such a portfolio?

More than a quarter of the mix is financials, nearly twice the broad market's weighting, and that includes pretty much every big, sleepy insurer. The consumer-discretionary slice captures the entire struggling automaker food chain, plus department stores and mall retailers such as Gap (though Target and Walmart make the cut, too).

The slower parts of energy are there, including Exxon Mobil and some refiners. Communications-services is AT&T plus a lot of Old Media (Viacom, Discovery Communications, News Corp.). And the entirety of the technology position (only 3.3 percent of the index) is three straitened, no-growth hardware players: Hewlett-Packard Enterprise, Western Digital and Xerox.

Interested in the stirrings of a comeback in the branded-household-products giants, spotlighted by Procter & Gamble's impressive results and 8 percent stock pop last Friday? Sorry, not here, too expensive.

This is not to belittle the companies in this category or to suggest their stocks might not be well-priced for decent returns over the long term. And of course, there are many ways to define "value" besides the one used for this pure-value strategy.

But the reeling homebuilder and auto stocks in there are suggesting those parts of the economy are on the downslope of this cycle — and the carmakers' performance even hints that there might not be a great "next cycle" for them depending how the "mobility industry" develops.

And if the market somehow decides that it should be assigning higher valuations to the disrupted industries such as mall-retail and Old Media, that implies it would compress the big valuation premiums on the companies such as Amazon, Alphabet and Netflix that have a far greater influence on the overall market.

The greatest run of value-stock outperformance in decades came in the three years following the puncturing of the internet and mega-cap stock bubble in the year 2000. By that point, "old economy" stocks were dirt cheap, and while the S&P 500 lost just about half its value peak-to-trough, an investor in cheap stocks outside of tech didn't really suffer badly.

The real economy had a fairly mild recession in 2001-2002, corporate profits imploded and some glamour-growth stocks were exposed as frauds along the way.

This doesn't mean we're at a similar place. But if this rolling correction or stealth bear market that's made its way from China to Europe to U.S. cyclical sectors this year and now is pressuring small-cap stocks inflicts more punishment on the so-far-resilient growth bellwethers such as Apple, Microsoft, Visa, Adobe, that could clear the decks for a relative outperformance of the boring, the beaten and the "disrupted."

Likely back to the growth favorites again

But is it easy to see that taking place as an elegant rotation with the broader tape hanging within a few percent of its record high?

Right now, if the market soon pulls out of this rough patch to attempt a fourth-quarter rally, it would most likely involve the growth favorites of the Nasdaq finding their footing and perhaps those big, defensive — but not necessarily cheap — groups doing a good share the lifting.

Best-case scenario for the cheaper strata of this market would be for all this "late-cycle" talk and investor positioning to be revealed as badly premature — for investors to gain assurance that in fact U.S. economic growth can continue above trend for a few more quarters, that credit markets will stay open for leveraged companies and

That would make the current market slippage and any further backsliding a buying opportunity for stocks, and that could include the value names.

It's probably not the most likely scenario — the momentum leaders late in a bull market tend to lead into its end. But it's not wholly implausible.