Value stocks had a record month in December, although high inflation dampened investors’ hopes of outsized returns.
Inflation rose 7% last month compared to the same period in 2020, up from the 6.8% year-on-year increase in November. While prices rose steadily throughout 2021, all value sub-factors outperformed the market at the end of the year, according to Investment Metrics, an analytics and data provider. Stocks with a high earnings-to-enterprise-value ratio, for example, outperformed the market by 2.4 percentage points. Other value sub-factors, such as earnings yield, cash flow yield and sales-to-price ratio, also outperformed the market by at least 2 percentage points.
Most of the growth sub-factors, on the other hand, were overtaken by the market, which rose 3.4% in December. High-growth stocks in earnings and sales lagged the market by 70 basis points and 120 basis points, respectively, according to Investment Metrics. At the same time, the sharp rise in interest rates of 6.2% in December (the US 10-year constant maturity rate rose from 1.42% to 1.52%) was accompanied by a a strong outperformance of the value sub-factors compared to the growth sub-factors. “The average gap between value and growth in December was 2.5%, consistent with our research showing that the gap between value and growth consistently widens whenever U.S. rates rise more than 5 % over the course of a month,” the report said.
Damian Handzy, head of research and applied analytics at Investment Metrics, said Institutional investor that “the higher interest rates rise, the greater the value [stocks] earn.” Because growth stocks are predicated on long-term gains, they suffer more from the discounting effect of rising interest rates than value stocks. Handzy added that one of the His company’s 2021 studies showed that value stocks would outperform growth stocks by 100 basis points for every 10% increase in interest rates.
Chris Brightman, managing director of Research Affiliates, wrote that investors should “position their portfolios for a high inflation environment by allocating to value stocks.” He noted that investors should think long term as inflation is unlikely to decline in the near future. Indeed, the central bank has reached the limit of what its monetary and fiscal tools can do to restore price stability. Nominal interest rates, he added, cannot exceed inflation in G7 countries, given their high debt levels during the pandemic. While governments can also raise taxes to curb inflation, they might have little incentive to do so, as “sustained inflation may be the appropriate policy path to diminish the real value of excessive public debt,” according to Brightman.
“Without relying on aggressive valuation reversion assumptions, we expect value stocks to offer long-term real returns above 6% in the US market and in the 8-10% range for Japanese, European and European markets. and emerging,” Brightman wrote. . He added that value stocks around the world “provide exposure to cyclical sectors of the economy that tend to benefit from reflation.”
Indeed, according to Investment Metrics, value stocks have not only emerged as an attractive investment opportunity in the United States, they have also outperformed market benchmarks in emerging markets and other developed countries. In Europe, all value sub-factors outperformed the market by at least 60 basis points, while two growth sub-factors – earnings growth and sales growth – lagged the market by 20 basis points and 70 basis points, respectively. In emerging markets, the value sub-factors generated returns ranging from 2.6% to 2.8%, all well above the market average of 2.1%.
“As inflation soars, value stocks around the world are providing a safe haven for investors, [thanks to] their exceptional expected long-term real returns,” concluded Brightman.