Large-Cap Growth Stocks Face Bear Market: Expert Sees 10%+ Returns in Small-Cap and Value

Market Expert Predicts Bear Market for Large-Cap Growth Stocks, Sees Opportunities in Cheaper Segments

Rob Arnott, founder of Research Affiliates, has issued a stark warning for investors in large-cap growth stocks, predicting a potential bear market that could significantly impact the S&P 500. This forecast comes as Arnott identifies promising opportunities in cheaper market segments, which he believes could deliver substantial returns over the next decade.

Arnott’s analysis suggests that small-cap stocks, small-cap value stocks, and non-US value stocks are poised to outperform, potentially yielding annual returns of at least 10% over the coming years. This prediction is based on current valuation levels and historical return patterns.

The S&P 500’s cyclically adjusted price-to-earnings (CAPE) ratio currently stands at a lofty 38, while other market segments show considerably lower valuations. For instance, US small-cap stocks, represented by the Russell 2000, have a CAPE ratio of approximately 19. The valuation gap between value and growth stocks is reminiscent of the dot-com bubble era, Arnott notes.

Global market valuations further support Arnott’s outlook. Small-cap value stocks, as measured by the Russell 2000 Value Index, have a CAPE ratio of 14. Non-US value stocks in emerging markets, Japan, and Europe are trading at historically low levels, with Japan and Europe showing a CAPE ratio of around 19, while emerging markets sit at 15.

Drawing parallels to the dot-com bubble, Arnott highlights the potential for market disconnection. He recalls that from March 2000 to March 2002, the S&P 500 fell 27% while the Russell 2000 Value rose 53%. Arnott suggests a similar scenario could unfold, with small-cap and value stocks thriving even as tech stocks decline.

For investors looking to capitalize on these potential opportunities, Arnott recommends considering various exchange-traded funds (ETFs). These include the Avantis U.S Small Cap Equity ETF (AVSC), Vanguard Russell 2000 Value Index (VTWV), iShares MSCI EAFE Value ETF (EFV), and Dimensional Emerging Markets Value ETF (DFEV).

As market dynamics continue to evolve, investors may need to reassess their portfolios in light of these predictions and consider diversifying into potentially undervalued segments of the market.