The years following the Great Recession have certainly been unusual in so many ways. But, these unusual circumstances persisted for so long that we no longer are puzzled by developments like negative-yielding bonds for countries or stocks with a price to sales ratio in the double or triple-digits.
Given that we had an economy with zero percent interest rates and low growth, there was exuberance and strong demand for growth stocks as there was a paucity of growth opportunities for investors. Thus, it's not surprising that growth stocks crushed value stocks. However, any student of market history could tell you that the pendulum inevitably always swings in the other direction.
Starting in 2021 and now accelerating in 2022, we are seeing this trend reverse with startling speed. Rather than low growth and low inflation, we have high growth and high inflation. Thus, it's possible for investors to find companies that are reporting double-digit earnings growth, and these stocks are significantly cheaper than growth stocks which remain expensive even after their recent declines.
For growth investors, there was some hope that 2021's underperformance was a blip and that conditions would revert back to what we experienced for much of the past decade. It's clearly not happening as indicated by inflation readings, employment data, and recent earnings reports. In fact, it's fair to say that conditions are even better for value stocks and worse for growth stocks.
Further, the gains in value stocks have been impressive but in line with earnings growth, so there is more upside if the economy can keep growing, and we start to see multiple expansion as tends to happen as bull markets persist. On the other hand, growth stocks got so expensive and these valuations could only be justified by making optimistic assumptions about future growth.
Of course, a crucial assumption is that rates and inflation would remain low. But, this is clearly no longer true. Another matter is that there is no floor on these stocks given that they would have to decline much further to become attractive to value investors. And, there's a big overlap between growth investors and momentum investors who are also likely to be sellers if this underperformance continues.
Therefore, investors should continue focusing on value and cyclical stocks in 2022 while not being tempted to buy the dip in growth stocks.