Conventional investment logic holds that value stocks tend to outperform during economic downturns, as investors seek stability, while growth stocks excel in bull markets, when optimism about future earnings is high. As rising interest rates weigh disproportionately on growth stock valuations, many expected them to take the biggest hit in the Fed’s recent cycle of economic tightening. But growth has defied expectations. Unprecedented optimism for future earnings, particularly in the AI space, have allowed growth stocks to significantly expand their valuations. 

Companies in the growth index are trading at 29 times their projected future earnings over the next 12 months, above their 20-year average of 20, according to Fundstrat’s data team. In comparison, the recent gains spurred by the trade war chaos has value stocks looking more expensive in comparison to historical levels. Value stocks are trading at a multiple of 17, above their 20-year average of 14. 

It’s a similar picture when looking at the price-to-book ratio. Value stocks are trading at a multiple of 3, above the 20-year average of 2, whereas growth stocks are at 11, above the 20-year average of 6. 

If AI momentum slows or Big Tech disappoints on results, growth stocks could fall fast. In that case, value stocks might come to the forefront as a more attractive alternative.

Skepticism towards tech’s astronomical success is already on the rise. The AI boom is starting to mature: no longer driven by speculative excitement and publicity, investors are becoming more selective, choosing companies with strong fundamentals over those simply promoting future gains. While the Magnificent 7 are racing to invest in AI, they have yet to fully deliver on the enormous growth expectations priced into their stocks. Only time will tell whether their ambitions come to fruition. 

As the Fed winds down its tightening cycle, historical data show that growth stocks typically benefit. But market participants are betting that this time value, too, could join in, contrary to the lag that growth stocks typically post as the Fed lowers interest rates. That’s because value stocks are often viewed as a reflection of the real economy, and the Fed likely won’t lower rates until it’s confident that the economy is in a good spot, as that could cause investors to panic.