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Investors still aren't betting on a better economy

August 1, 2013: 3:17 PM ET

Value stocks -- not growth ones -- are leading the market rally.

Stock market tickerFORTUNE -- Economists have their sights set on better growth ahead.

Earlier this week, the Federal Reserve said in its monthly statement that while growth was still "modest," it expects the economy will pick up from its current pace. Indeed, on average, economists are expecting the GDP to grow at 2.8% next year, and 3% beyond that. That would be a welcome change from the 1.7% the government just reported that GDP grew in the second quarter of the year.

One group, though, doesn't seem to be buying all the economic optimism: investors. Yes, the S&P 500 (SPX) is up just over 19%. But the stocks that are rising the most are not the ones that investors typically run to if they are betting on a better economy. Health care stocks, for instance, are normally considered a defensive investment, yet they are the best performing industry group in the index. And in general, the value stocks of the S&P 500 have outperformed growth stocks this year, 20% vs. 17%.

MORE: El-Erian: The Fed Punts, for now

"I'm not sure enough people are appropriately discounting the potential for growth," says Jason Trennert, the chief investment officer of investment firm Strategas, who thinks the market can rise from here.

Investors perhaps have a good reason to be worried about growth. First of all, this has been the growthless recovery. Nonetheless, corporations have been able to buck the trend, producing double-digit profit increases despite the weak GDP. But that could be coming to an end.

One of the main drivers of the outsized earnings growth was falling interest rates. That allowed companies to refinance debt they had borrowed a few years ago at lower rates. Then that allowed companies to lower their costs and boost their profits, even if their actual earnings weren't increasing. But after a number of years of low interest rates, companies have probably refinanced as much of the debt they can. What's more, with interest rates rising recently, the benefits companies will get from refinancing is falling.

Indeed, profits on average for the companies in the S&P 500 look like they rose just less than 2% in the second quarter vs. a year ago.

MORE: Why the economy could grow even if the housing market slows

Another sign that investors think growth won't been that strong is valuations. The S&P 500 is currently trading at just over 15 times this year's expected earnings. Historically, that's about average. But it's not nearly as high as it was back in the 1990s, when the price-to-earnings ratio regularly topped 20, and investors were betting on growth.

"We are talking about is degrees of bullishness at this point," Josh Brown, an investment advisor with Fusion Analytics, who goes by name @reformedbroker, wrote on Twitter on Thursday. And right now it appears the economists are slightly hotter than the market.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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