Behavioral
finance
researchers
have
identified
several
cognitive
errors
that
often
cloud
investors’
judgment.
One
of
the
most
common
is
recency
bias,
or
the
tendency
to
place
too
much
weight
on
the
latest
performance
trends
while
giving
short
shrift
to
other
factors,
such
as
fundamentals,
valuation,
or
long-term
market
averages.
It’s
not
always
obvious
when
recency
bias
might
be
creeping
in
to
the
investment
decision-making
process.
For
one,
there’s
evidence
near-term
performance
trends
do
persist.
This
is
also
known
as
the momentum
effect,
in
which
stocks
with
above-average
performance
over
the
past
12
months*
often
continue
to
pull
ahead.
And
at
the
asset
class,
region,
and
style
level,
performance
trends
can
persist
for
much
longer
periods –
even
a
decade
or
more.
In
this
article,
I’ll
look
at
three
performance
dichotomies
that
have
been
seemingly
unstoppable:
large
versus
small,
growth
versus
value,
and
US
versus
international.
I’ll
also
examine
the
reasons
behind
their
persistent
dominance
as
well
as
countervailing
factors
that
investors
might
want
to
consider.
Large
Versus
Small
In
theory,
smaller
companies
have
more
room
to
grow
because
they
haven’t
yet
reached
their
full
potential
or
scale.
Academic
research
has
often
highlighted
the
long-term
performance
advantage
of
smaller-cap
stocks.
They’ve
pulled
ahead
of
their
larger-cap
peers
by
about
two
percentage
points
per
year
over
the
full
period
from
1926
through
mid-2024.
This
performance
edge
was
driven
by
their
strong
advantage
over
several
periods,
such
as
the
late
1930s
and
early
1940s,
the
stretch
from
1974
through
1983,
the
early
1990s,
and
most
of
the
period
from
2000
through
2010.
More
recently,
however,
large-cap
stocks
have
trounced
their
small-cap
counterparts
by
more
than
six
percentage
points
per
year,
on
average,
over
the
trailing
10-year
period
through
June
30
2024.
This
disappointing
showing
was
partly
driven
by
differences
in
sector
composition.
Compared
with
the
market
overall,
small-cap
benchmarks
have
less
exposure
to
technology
stocks
and
more
exposure
to
“old
economy”
sectors
such
as
consumer
cyclicals,
financials,
real
estate,
and
industrials.
Despite
generally
strong
economic
growth,
these
sectors
haven’t
kept
pace
with
technology-related
stocks.
However,
small-cap
stocks
are
often
more
economically
sensitive
than
stocks
issued
by
larger
firms
and
can
therefore
perform
better
during
periods
of
strong
economic
growth.
They’re
also
cheaper.
Whereas
large-cap
stocks
covered
by
Morningstar’s
equity
analysts
are
currently
trading
at
a
7%
premium
to
their
Fair
Value
Estimates,
small-cap
stocks
are
trading
at
a
14%
discount.
Growth
Versus
Value
There’s
been
another
long-running
performance
dichotomy
between
growth
stocks,
which
sport
above-average
growth
in
earnings,
sales,
cash
flow,
and/or
book
value;
and
value
stocks,
which
trade
at
relatively
low
prices
on
various
metrics.
Growth
stocks
have
outperformed
value
issues
by
a
wide
margin
over
the
trailing
10-,
15-,
and
20-year
periods.
Value
stocks
held
up
much
better
than
growth
stocks
during
the
2022
bear
market,
but
not
enough
to
offset
their
lagging
returns
in
previous
periods.
One
reason
for
this
performance
shortfall:
value
stock
indexes
are
light
on
technology
stocks,
especially
the
“Magnificent
Seven”
group
of
mega-cap
tech
stocks
that
have
powered
the
market
in
recent
years.
At
the
same
time,
they
have
more
exposure
to
lagging
sectors
such
as
energy,
financial
services,
and
utilities.
What
might
reverse
this
trend?
Some
possibilities
could
be
a
valuation-driven
correction
or
an
economic
downturn
followed
by
a
recovery.
In
addition,
growth
stocks
are
trading
at
relatively
steep
prices,
even
if
they
continue
to
generate
above-average
earnings
and
sales
growth.
The
average
growth
stock
held
by
Vanguard
Growth
ETF
(VUG) is
currently
trading
at
a
12%
premium
to
its
estimated
fair
value.
Holdings
in
the
corresponding
value
fund
(Vanguard
Value
ETF
[VTV])
are
trading
about
in
line
with
their
Fair
Value
Estimates.
US
Versus
International
The
third
long-running
performance
gap
is
between
US-based
stocks
and
equities
from
other
markets
around
the
world.
Annualised
returns
for
international
stocks
have
fallen
behind
those
of
US
stocks
by
nearly
four
percentage
points
per
year
over
the
past
20
years
and
even
bigger
margins
over
the
trailing
10-
and
15-year
periods.
Sector
exposure
is
one
factor
behind
this
poor
performance.
Non-US
stock
benchmarks
are
light
on
technology
and
relatively
heavy
on
old-economy
sectors
such
as
basic
materials,
financial
services,
and
industrials.
Because
non-US
stocks
have
fallen
behind
for
so
long,
however,
they
now
offer
more
attractive
valuations.
US
stocks
are
currently
trading
at
about
33
times
long-term,
inflation-adjusted
earnings
(a
multiple
also
known
as
the
CAPE
or
Shiller
P/E),
compared
with
a
longer-term
average
of
about
24.5.
Thus,
even
if
US-based
companies
continue
to
deliver
exceptional
fundamentals,
that
may
already
be
priced
into
their
stocks.
Non-US
markets,
meanwhile,
have
an
average
CAPE
of
about
19.8
as
of
May
30,
2024.
Currency
movements
are
another
factor
to
consider.
The
US
dollar
has
generally
trended
higher
against
other
major
currencies
over
the
past
10
years
or
so.
That
has
been
a
negative
for
international
stocks
because
their
returns
are
worth
less
when
converted
into
dollar
terms.
However,
there’s
no
guarantee
the
dollar’s
strength
will
continue
forever.
Some
international
managers,
such
as
Oakmark
International’s David
Herro,
have
recently
argued
that
non-US
currencies
are
better
valued
and
should
eventually
appreciate
as
they
return
to purchasing
power
parity.
Conclusion
It’s
impossible
to
know
if
and
when
these
seemingly
unstoppable
trends
will
reverse.
Maybe
we
really
are
in
a
new
era
when
traditional
valuation
measures
are
less
relevant
than
they
once
were
and
mega-cap
growth
stocks
in
the
US
continue
to
dominate.
To
be
fair,
market
valuations
aren’t
as
lofty
as
they
were
at
the
height
of
the
dotcom
bubble
in
1999.
That
said,
seasoned
investors
have
learned
to
be
cautious
when
they
hear
shouts
and
murmurs
arguing
that
“it’s
different
this
time.”
When
those
voices
get
louder
and
louder,
some
caution
is
warranted.
*Most
researchers
and
index
providers
exclude
the
most
recent
month
from
momentum
calculations
because
of
another
market
anomaly
(the
reversal
effect)
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