Photo: Getty Images When inflation heats up, everyone looks for good deals when they go shopping . The same is proving to be true in the stock market this year—and in dramatic fashion.
It’s a reversal in a rivalry that’s as fierce as that of the Yankees and the Red Sox: growth vs. value. In other words, whether it’s best to buy companies with dazzling, if sometimes dubious, prospects for sales and profit growth, or focus on stocks that look cheap based on the value of the company’s assets, even if earnings growth is relatively modest.
After languishing behind growth for most of the past decade-plus, value investing has come back with a vengeance. Take the S&P Pure Value Index, which tracks companies with low valuations based on the ratios of their share price to their book value, earnings, and revenue. Since the middle of November, the index has returned close to 8% with dividends. Over the same period, its sister index, the S&P Pure Growth, has lost investors 25%.
For the 12 years before that, the growth index’s return of 650% was almost double that of the value index’s. The sudden switch in fortunes has been a bonanza for funds focused on cheap stocks. Among exchange-traded funds alone, value strategies have seen inflows of $55 billion so far in 2022, compared with a net outflow of $1 billion for growth, according to Bloomberg Intelligence . So is it time for value money managers to gloat?
“There’s no upside to doing that, because we looked pretty stupid for a while,” says Rob Arnott, the founder and chairman of Research Affiliates and a longtime advocate for value investing . Instead, he says he’s kept his focus on research . Arnott has been diving into the numbers to figure out what exactly caused growth to outshine value for so long and to build his case that value’s outperformance can last. He argues that it can continue for perhaps several more years, even as many other investors anxiously wait for growth stocks to retake the lead.
One common explanation for the long rise of growth and the recent return to value ascribes it all to interest rates. Low rates are thought to help growth stocks almost mechanically: Cheaper money makes investors more willing to take risk in hopes of a bigger pay-off. But Arnott says that it’s more complicated and that the deeper story is inflation. Focusing only on interest rates is an easy mistake to make since rising rates usually—but not always—accompany an increase in inflation.
“High inflation is good for value,” Arnott says. It increases uncertainty about the future and makes it harder for companies to plan. In times like that, he says, “boring, steady-as-you-go businesses” become more attractive.
While many on Wall Street hope inflation will settle back down from north of 8% to something closer to the Federal Reserve’s goal of 2% , Arnott is betting that consumer price increases will stay elevated for a while. One big reason: Home prices have surged 39% since the end of 2019, according to the S&P CoreLogic Case-Shiller U.S. National Home Price Index. Arnott figures that’s bound to keep feeding into what’s known as owner’s equivalent rent , which accounts for about a quarter of the consumer price index.
The other popular storyline that propelled the growth-stock frenzy was that tech-savvy companies would disrupt every industry they enter, putting the stalwarts of the corporate world out of business one by one. Some of the top weightings of the Pure Growth index at its peak in November were stocks such as Nvidia (down 43% since then), Tesla (down 37%), and Etsy (down 72%). Meanwhile, the Pure Value index’s top stocks at the time— Berkshire Hathaway , Cigna , and Archer-Daniels Midland —all have double-digit gains. The disruption narrative proved to be a little overhyped. “Were the value companies getting crushed? No, their valuations were getting crushed,” says Arnott. “Their businesses were doing OK.”
Ultimately, though, what value investors are betting on is that growth and value stocks will return to their historical relationship. According to Arnott’s calculations, it’s normal for growth stocks to be about five times as expensive as value based on book value—the value of a companies’ assets minus its liabilities. Even after the reversal of the last six months, Arnott calculates that growth is still eight to nine times more expensive.
Arnott’s faith in a long value renaissance is far from universally held on Wall Street. After all, we’re talking about a comeback that’s a few months old compared […]
source We’re All Bargain Hunters Now That the Market’s Growth Spurt Is Over
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