Value shares have performed better so far in 2022 as investors have rotated out of long-favoured growth stocks into unloved names.
The MSCI World Growth index, the largest constituents of which are Apple, Microsoft, Amazon and Google’s parent company Alphabet, lost 9.3 per cent in January, with tech names selling off in the context of a rising interest rate environment.
By comparison, the MSCI World Value index, which includes banks like JP Morgan Chase & Co and pharma firms like Pfizer, lost just 1.2 per cent over the month.
Value stocks have outperformed growth peers so far in 2022, but they have generally struggled over the first quarter for the last decade
Value shares are companies perceived to be trading at a cheaper price than their fundamentals suggest they should, whereas growth companies often trade at higher valuations reflecting the possibility of big future profits.
Over recent years growth has had the upper hand with consistently rising share prices encouraging investors to pay up for the promise of profits tomorrow, whereas beaten down stocks have remained unloved – even if they can bring more certainty on profits today.
The switch to a world of persistently higher inflation and rising interest rates has brought investors to question whether profits today bought at a lower price might be a better option though.
Richard Hunter, head of markets at interactive investor, explained: ‘Rising Treasury yields in the US, and a more hawkish than expected stance from the Federal Reserve has prompted a bout of rotation from high growth stocks, such as technology, into value – therefore boosting financial and industrial shares.
‘Interest rate-sensitive stocks, such as the banks, have attracted more buying interest ahead of the imminent fourth-quarter reporting season.
‘Although it is extremely unlikely that rates will rise to historical levels, there is nonetheless an improvement in sentiment given that the impending environment should improve prospects for the banks over the coming months.’
Some have described this outperformance as ‘the great rotation’, but data from interactive investor suggests that, historically, this trend may not last.
Lloyds was among the most bought stocks on interactive investor in January
It’s been relatively level pegging over the long term, with value outperforming growth in the first quarter of the calendar year 48 per cent of the time in the last 23 years.
But the ultra-low interest rate era brought about by the financial crisis and the emergence of the ‘mega cap’ tech giants has meant growth has outperformed in 70 per cent of the first three months in each year of the last decade.
In fact, in six of the seven years over the last decade in which growth outperformed value over the first quarter, it did so by more than 3 per cent, which head of equity strategy at interactive investor Lee Wild said demonstrates ‘just how one-sided a bull market can be’.
That also illustrates why investors are paying attention to the fact that value has topped growth at the start of 2022.
Wild said that this stands in contrast to how if you go further back, ‘the story is far less clear cut’.
He added: ‘Significantly, the shift to value in Q1 2021 was the second-biggest outperformance in Q1 for any strategy in the past 25 year [at] 9.2 per cent.
‘Only the pandemic-driven rally was more one-sided (for growth at 12.6 per cent). It was also the biggest Q1 outperformance for value since 2011 when global stock markets had just experienced a rapid rally over the previous six months.
‘Last year’s switch to value was completely understandable given a spectacular rally from the Covid low had put popular tech stocks on sky-high valuations.’
Growth has outperformed value in 70 per cent of the first three months in each year of the last decade.
BP and Ocado results demonstrate market rotation
Yesterday saw two high profile UK companies release results and their recent share price peformance is perhaps a good example of the growth vs value argument.
Ocado, considered by many to be a tech firm more than a grocer, is a classic disruptive growth stock that investors look at for future profits, whereas BP is a value stock, making profits now and trading on a low price to earnings multiple, with a big dividend yield, but seen as offering limited future growth.
Chief market analyst at IG Group Chris Beauchamp said: ‘That Ocado has reported numbers on the same day as BP is an exquisite irony, as the baton of market leadership continues to pass to “physical economy” stocks like BP and away from the “growth tomorrow”, one-hit wonders like Ocado.
‘The divergence is stark, but reflects how investors have flocked to previously dull stocks like BP in order to benefit from the reopening of the global economy.
‘While Ocado is still promising growth in the future, it is still viewed as too expensive in a world of higher rates, and so we could still see some additional downside for the time being.’
Are investors adjusting their portfolios?
To some extent, interactive investor customers took part in the rotation in January, with Lloyds, BP and Unilever the most-bought stocks on the platform for the month.
Although these are big name FTSE 100 companies they fall more into the value than growth camp, albeit Unilever often gets termed quality growth but has been unfashionable for some time.
However, Tesla was the fourth most-bought, while tech funds and investment trusts made it into the top 10 best buys.
And investors hunting tech growth are still picking up funds and trusts. L&G Global Tech Index Trust was the third most bought fund, and Allianz Technology and Polar Capital Technology were in fourth and 10th position respectively in the investment trust charts.
Hunter said: ‘With many of the larger tech companies trading at extremely high valuations given future growth prospects, these stocks are particularly sensitive to a rising interest rate environment.
‘At the same time, interest rates should settle at a relatively low level by historical standards, which in turn could provide some future relief to the sector.
‘In the meantime, the continuing threat of regulation overhangs the sector, and the stratospheric rise of many of the big tech names may also have provided an exit point for some investors to lock in profits.’
By contrast, a rising interest rate environment can be beneficial to the old world sectors that dominate the UK market, such as banks and energy stocks.
Hunter added: ‘In the UK, [the rotation] has fed through to strong performances across these sectors in the first few days, and investors wishing to join the rotation trade could consider the longer-term potential benefits.
‘In terms of market consensus, the current preferred plays in the bank sector are Barclays and Lloyds Banking, and in the energy sector, Shell.’
But investors should consider that the shift away from ultra cheap money is a complex scenario and it may not simply be a question of tech growth bad, dependable dividend-payers good.
Lead manager of the Somerset Asia Income Mark Williams said that while ‘fast growing companies where investors have to discount earnings far into the future to justify current valuations’ – as is the case with much of the tech sector – are under pressure in a rising rate environment, so too are ‘high yield bond proxies’ – shares that are likely to offer predictable returns – ‘with little growth’.
He added: ‘These companies were highly in favour post-Covid but they have fallen sharply and I expect there will be more pain to come for many.
‘For us, dividend growth stocks are in the sweet spot. These are quality, well-run companies that are growing sustainably, generating free cash flow and both investing for future growth while paying some dividends to current shareholders.
‘They might not be growing as quickly as some of the racier growth stocks out there, but they are solid, dependable and will compound a healthy return over the long-term.’
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