Tesla wiped the floor with analysts’ consensus forecasts for its third-quarter results and Netflix missed, to get the reporting season off to a mixed start for momentum-fuelled technology stocks.

Netflix’s shares sagged and Tesla’s advanced only modestly to again raise the issue of valuation and just whether there is so much good news baked into these stocks that they may find it hard to make further headway, at least in the near term.

In this context, Netflix’s fourth failure to break through the $550-a-share mark is particularly eye-catching, even if the temptation to run with the narrative that technology stocks are relatively immune to the pandemic and worthy of premium valuations because of the relative scarcity of consistent earnings growth right now is               quite understandable.

One-way traffic

This in turn begs the wider question of whether now is the time to (once again) address the outperformance of ‘growth’ stocks relative to perceived ‘value’ names. After all, growth stocks in the US have shown ‘value’ stocks a clean pair of heels over the past decade and since 2017 in particular.

This can be seen by analysing the performance of the Invesco QQQ Trust, an exchange-traded fund (ETF) traded in the US and designed to track and deliver the performance of the heavyweight NASDAQ 100 index (minus its running costs), relative to the fellow US-listed iShares Russell 2000 Value ETF, which seeks to do the same for a basket of around 1,400 American small-cap value stocks:

Since January 2010, the iShares Russell 2000 Value ETF is up by 135% in capital terms, for a compound annual return of 8.2% - so it is hard to argue that value has ‘failed’ as a strategy. What is clear is that growth has simply done so much better, offering a 521% return, or a compound annual growth rate of 18.5%, as benchmarked by the Invesco QQQ Trust.

The performance gap between the two stands at a decade high.

But it may surprise less experienced investors to learn that the last decade’s stellar outperformance from growth has only just begun to cancel out the prior decade’s grinding period of marked underperformance relative to value, taking 2000’s launch of the iShares Russell 2000 Value ETF as a starting point.

That miserable ten-year showing followed the bursting of the tech, media and telecoms (TMT) bubble, so investors in tech and growth stocks now need to ask themselves whether they should fear a repeat.

Watch inflation

Valuation alone is never a catalyst for out-or–underperformance, but it is the single biggest determinant of long-term investment returns (and a decade seems like a suitable definition of long-term).

If tech earnings keep growing and surprising on the upside, if interest rates stay low, if inflation stays subdued and the Facebooks and Apples of this world use the combination of product innovation and acquisitions to maintain and even deepen their powerful competitive advantages, then many investors will be tempted to dismiss valuation as an irrelevance.

But the trouble could start if regulators begin to take a hand, earnings disappoint (as Big Tech does not prove to be immune to the pandemic after all or the law of large numbers means it simply becomes harder to generate strong percentage growth figures) or the wider economy starts to accelerate and inflation picks up.

None seem likely now but that is why growth has done so well relative to value.

If a Covid-19 vaccine is quickly and successfully developed and distributed, then stocks which are seen as ‘immune’ from the pandemic may be less in demand and seen as less worthy of a premium valuation.

Equally, if growth and inflation pick up, then investors may not be so inclined to pay such premium multiples for growth companies, if rapid earnings increases can be acquired much more cheaply along downtrodden value, cyclical plays like industrials, financials and consumer discretionary plays.

Moreover, an increase in inflation could force government bond yields higher, even if central banks decline to raise interest rates and let inflation run hot, as per the US Federal Reserve’s new ‘average’ inflation target.

Prior periods of rising 10-year US treasury yields have coincided with attempted rallies in ‘value’ names, so perhaps a return to economic growth and inflation could be the trigger for a sustained period of underperformance from ‘growth’ and ‘tech’ stocks relative to value ones.

And while the concept of rising inflation may seem fanciful for now, investors should not forget that this is what central banks and governments crave to help the globe manage its crushing debts, so they may stop at nothing until they get it. The latest money supply growth figures from the US in particular are eye-popping and should be followed closely as a potential lead indicator.

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