A stock trade that crushed the market last year could come crashing back to Earth

REUTERS/Lucas Jackson

• The stock market growth trade dominated in 2017, dwarfing equity benchmarks.
• The strategy was especially strong in comparison to the so-called value trade, although Bank of America Merrill Lynch thinks the tables could be turned in 2018.

In 2017, as the scorching-hot stock market posted a seemingly endless string of record highs, the "growth trade" was one of the shining stars.

The strategy, which involves buying stock in companies expected to see outsized profit expansion, provided returns that dwarfed benchmarks, as the Russell 1000 Growth Index surged 28%. It also handily beat the so-called value trade, used by investors who seek stocks trading at discounted prices.

In fact, growth beat value by 17 percentage points, the biggest gap since 2009, when the 8 1/2-year equity bull market was just getting underway. But the party is over, and the tables may soon be turned, says Savita Subramanian, Bank of America Merrill Lynch's head of US equity and derivatives strategy.

Bank of America Merrill Lynch

At the heart of a possible growth-versus-value trade reversal is GOP tax reform, says BAML. The firm points out that the newly-passed tax plan will "accelerate the profits cycle," something that gives an edge to the value strategy. That's because when a large swath of the market is experiencing robust earnings expansion, it's more difficult for existing growth stocks to keep standing out.

The chart below shows this dynamic in action. As seen on the left, the growth trade vastly outperforms when profits are slowing down. But as the right side shows, value is actually the better bet when they're accelerating.

Bank of America Merrill Lynch

But that's not to say that the growth trade is dead in the water. According to a quantitative model maintained by BAML, growth investing is a strategy that outperforms in the final stages of a stock bull market.

And given that some market experts are saying that the ongoing rally is on its last legs, depending on how 2018 unfolds, it's still entirely possible that growth will emerge victorious again.