In pulling together data for the upcoming strategy report card to be published in the August issue of SMI, I noticed some interesting details about the performance rotation between the various Upgrading fund categories. Since we've expanded our coverage in those quarterly report card articles to include discussions of the Premium Strategies now, I don't usually have room to delve into these types of details anymore, so I thought I'd note them here for those who are interested in a "deeper dive."

The first thing that stands out is the huge contrast in returns between Large/Growth and Small/Value stocks through the first half of 2017. The average large/growth fund tracked by Morningstar was up 14.1% at mid-year. Contrast that to the paltry 0.5% gain of the average small/value fund — a massive difference.

That performance swing is all the more striking given that it's a total reversal of what we saw last year. In 2016, the average large/growth fund was up just 3.2% while the average small/value fund gained 26.0%. They've literally swapped best/worst positions from last year to this year. It's an instructive lesson on the value of diversification, as these pivots can be sharp and there's not always an obvious catalyst to these twists and turns.

Adding some depth to this discussion is the fact that, 2016 aside, growth has been dominating value for quite a while now. I did a quick comparison of the ETFs that track the Russell 2000 Value index (IWN - small/value) and the Russell 1000 Growth index (IWF - large/growth). Over the past three years (thru 6/30 of this year), large/growth has beat small/value by roughly 4% per year. Extending our view out to 10 years, large/growth has led by almost 3% per year.

That's a very significant performance difference, which is immediately obvious after converting those annual percentages into total returns. Over the past 10 years, IWN (small/value) is up 76.1%, while IWF (large/growth) is up 130.7%.

Mark Hulbert wrote an article in a recent edition of Barron's, in which he cites researchers Fama and French (who we wrote about last week), pointing out that over the past 12 years, value lagged growth by an annualized average of 0.7%. Yet over the much longer term, going all the way back to 1926, they note that value has beat growth by an average of 4.8% per year.

Given the long-term edge value investors have had, why don't more investors choose that investing approach? Because of periods like the past 12 years: it's really, really hard to endure prolonged periods when your strategy or approach appears to be failing. Much easier to roll your account into an index fund and go with the flow.

Hulbert goes on to note:

Frustrating as the last dozen years have been, they are not unprecedented. In fact, there was one other 12-year period since 1926 in which value, on balance, lagged growth. That period was — you guessed it — the one that ended in March 2000, the month the dot-com bubble burst.

Hmm, an aging bull market powered by a narrow group of huge tech stocks with obscene valuations, elevating the market indexes while most other stocks get left behind. Meanwhile, the Federal Reserve starts ratcheting up interest rates in the background...haven't we seen this story before?

And yet, as we've pointed out many times, even if this chapter ends in a similar way to the dot-com bubble bursting, the timing aspect is anything but certain. I was worried about a lot of these same factors a year or two ago, so who's to say there won't be another two years of gains before it's over? So instead of trying to predict the endgame, we rely on diversification instead (between strategies as well as asset classes). We know continuing to invest exposes us to the risk of giving back some of our current gains during the next bear market. But we also know that the protective properties built into Dynamic Asset Allocation (and which we continue to explore for our other strategies) have been effective in limiting the damage done by past market downturns.

So until the next bear finally arrives, we encourage you to continue to follow your long-term investing plan, while being mindful that your plan should be structured in such a way that a bear market arriving as soon as next week (or as far off as a few years) won't come as a surprise.