Subject: OT Large Growth Small Value Divergence
The result of the rise in valuations of large-growth stocks is that they are now trading well above historical averages. And the result of the decline in valuations of small-value stocks is that they are now trading well below historical valuations. This has important implications for future expected returns. Simply put, valuations are the best predictor we have of future returns, and the longer the investment horizon, the larger the role of valuations. However, over short horizons, such as one year, current valuations have virtually no predictive value.

The same divergence in performance in the US between large and small stocks and growth and value stocks has also occurred between US stocks and international stocks.

The fact that every single risk asset goes through such long periods of underperformance, and there is no evidence that investors can forecast when such regimes will change, is the reason we diversify the sources of risk in a portfolio—eliminating the risk that all our investments are in the wrong basket at the wrong time. The solution is to build a broadly diversified portfolio that includes unique sources of risk and stay the course.

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