Value stocks

friend or foe of Value stocks in 2022?

Time flies in the investment world and the themes that emerged over the past year have accelerated, including high realized and anticipated inflation, the risk of a global recession and the outbreak of the Russian-Ukrainian conflict. In this context, we have revisited the question of the performance of value stocks, in particular relative to growth.

(Note. A growth stock is a stock of a company that is expected to grow at a significantly higher rate than the average market growth. A value stock is a stock that trades at a lower price than the intrinsic performance of the the company might otherwise indicate.) .

The story so far

Inflation comments have gone from “passing” to “temporary” to “sticky” and are now approaching “entrenched” at a rapid pace.

During this period of uncertainty, Value stocks have performed well, which coincides with (but is not entirely due to) higher inflation. Very expensive growth stocks, hit by both slowing growth and the inability to source materials, sold off significantly.

We think value will continue to do well for some time (or growth will do badly) as the issues driving inflation are unlikely to be resolved anytime soon, and the fallout will take some time. to be felt.

How has Value performed?

Although there is a fairly well-known positive relationship between returns to value and inflation, the relationship is by no means simple. It was probably more important during the high inflation period of the 1970s, when oil prices were high and inflation was not targeted by central banks, as it is today.

However, two comments on this relationship:

1. Inflation is on the rise, sticky and expected to stay elevated for some time

We know that higher inflation means higher nominal interest rates and a higher cost of debt for businesses. Companies that rely on longer dated cash flows for their valuation – so-called “long duration” companies – are much more affected by interest rate increases than those with shorter durations. These longer duration stocks are generally the expensive growth stocks and are devalued and sold more than the shorter duration stocks, which are generally the cheapest value style companies.

2. Economic growth expectations are mixed

When projections of expected growth and future cash flow are positive, the market is willing to pay for expensive stocks, betting that all will be well. However, if this growth is interrupted, as it has been recently, expectations are less optimistic and expensive companies are sold in favor of companies offering more certain near-term opportunities, especially those that are cheaper.

It’s both an “expensive” and a “risky” story

Combined, these two effects played out as expected, with the stock significantly outperforming growth over the past 6-9 months in most markets. The graphs below show this.

The first chart shows that value and growth performance (measured here as the top and bottom Book-to-Price quintiles) stopped diverging in mid-2021, and value has seen a resurgence. However, as the second chart shows, history has also been about certainty. Low volatility (ie low risk) stocks have significantly outperformed high volatility/high risk stocks since the middle of last year.

(Note. Book to Price is a valuation measure that compares a company’s current market value to its book value).

We have thus witnessed a double rotation – far from Dear Growth at cheaper Value, and far from risk Growth to more stable Assess.

Chart 1: Performance of the upper and lower quintiles of volatility over 12 months (MSCI ACWI ex AU)

Source: Realindex, Factset. Data as of April 30, 2022

Chart 2: Book-to-Price top and bottom quintile performance (MSCI ACWI ex AU)

Source: Realindex, Factset. Data as of April 30, 2022

The following two charts break down this difference in performance between the All-World (ACWI) and Australian universes since the start of 2022. In each case, the outperformance of value over growth has been clear.

Chart 3: Value outperformance versus growth MSCI ACWI ex AU

Source: Realindex, Factset. Data as of April 30, 2022

Chart 4: Value outperforms ASX 200 growth

Source: Realindex, Factset. Data as of April 30, 2022

Are we expecting this to continue?

Increases in realized or expected inflation tend to be correlated with a positive relative return to value, relative to growth.

Before COVID, an average inflation rate of around 2% was expected by the market over the following 10 years. With COVID, that dropped sharply as an economic contraction was likely. Since then, it has rebounded, returned to 2% and is now approaching 3%.

The standard measure of expected inflation is known as the “break-even bond inflation rate” (BBIR), and over the past two months the BBIR has risen from 2.5% to nearly 3 %.

The stock’s recent outperformance has followed some of this shift in inflation expectations, more due to the growth sell-off than a strong rebound in value (although that has also happened).

Chart 5: Breakeven inflation and value-growth gap

Source: Realindex, Factset. Data as of May 5, 2022

We cannot, of course, establish a direct link between expected inflation and future stock performance, although there is clearly a strong recent relationship.

While value has done well recently, the cumulative outperformance of growth versus value over the past decade is still much larger, and we can see that the trend in valuation metric deviations has not flattened out. only slightly corrected. This reassures us that the resurgence in value still has a long way to go.

David Walsh is Head of Investments at Realindex Investments, a wholly owned investment management subsidiary of First Sentier Investors, a sponsor of Firstlinks. This article is general information and does not take into account the situation of an investor.

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