By Michael Brush
Investing is all about being in tune with the trends. Here’s one to be aware of for 2022: Value stocks will most likely beat their growth counterparts.
The trend is already under way. Consider:
* The Vanguard S&P 500 Growth Index exchange traded fund /zigman2/quotes/200197877/composite VOOG +0.20% is down 5.6% year to date, while the Vanguard S&P 500 Value Index fund /zigman2/quotes/201497396/composite VOOV -0.06% is flat.
* Value groups including banks and energy stocks are crushing growth stocks like Ark Invest’s favorite names. The KBW Bank Index /zigman2/quotes/210598427/realtime BKX +0.40% and the Energy Select Sector SPDR ETF /zigman2/quotes/206420077/composite XLE +1.13% are up 6%. In contrast, the ARK Innovation ETF /zigman2/quotes/204808965/composite ARKK +2.73% has slid over 13%. That ETF is filled with growth darlings like Tesla /zigman2/quotes/203558040/composite TSLA +4.96% , Coinbase Global /zigman2/quotes/225893452/composite COIN +8.05% , Teladoc Health /zigman2/quotes/207420252/composite TDOC +0.94% and Zoom Video Communications /zigman2/quotes/211319643/composite ZM +5.41% .
Here’s a look at four forces favoring value over growth, followed by 14 value stocks to consider, courtesy of two value investing experts.
1. Rising interest rates favor value stocks
A lot of investors value stocks using the net present value (NPV) model — especially high-growth stocks that have expected earnings in the distant future. This means they discount projected earnings back to the present using a discount rate, typically the yield on 10-year Treasuries /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +0.08% . When the discount rate goes up, NPV goes down.
So naturally, when 10-year yields rise as they are now, expensive stocks in areas like tech underperform the cheapest stocks in areas like cyclicals, financials and energy, points RBC Capital Markets strategist Lori Calvasina.
Likewise, price-to-earnings (P/E) multiples of the most expensive stocks become inversely correlated with 10-year yields during Federal Reserve hiking cycles, she points out. The reverse is true for value stocks.
“The least expensive stocks have historically outperformed the most expensive stocks when the 10-year yield is rising,” she says.
Ed Yardeni at Yardeni Research projects the 10-year yield could rise to 2.5% by yearend, from around 1.79% now. If he is right, that suggests value outperformance will continue. Though there will be counter-rallies in growth and tech along the way (more on this below).
Here’s a chart from RBC Capital Markets showing that value historically outperforms as yields rise. The light blue line represents bond yields, and the dark blue line represents cheap stock performance relative to expensive stocks.
2. Higher inflation is positive for value strategies
This has historically been the case, points out John Buckingham, a value manager at Kovitz Investment Group who pens The Prudent Speculator stock letter. He expects a repeat now. Part of the reason is that inflation fears drive up the yield on 10-year bonds, creating the detrimental NPV effect for growth names (described above).
Inflation accelerated at the fastest pace in December since 1982, the government reported Wednesday. It was the third straight month in which inflation measured annually exceeded 6%.
But another factor is at work. During inflationary times, companies with actual earnings can boost profit margins by raising prices. As a group, value companies tend to be more mature, which means they have earnings and margins to improve. Investors notice this, so they’re attracted to those companies.
In contrast, growth names are characterized by expected earnings, so they benefit less from price hikes.