December was a strong month for value stocks, even though high inflation dampened investors’ hopes for large returns.
Inflation increased 7 percent in November compared to the same time period in 2020. This was an increase of 6.8 percent year over year. Investment Metrics, an analytics and data provider, reports that prices have increased consistently through 2021. According to Investment Metrics all value sub-factors performed better than the market at year’s end. Stocks with a high earnings-to-enterprise value ratio, for example, exceeded the market by 2.4 percentage points. Other value sub-factors like earnings yield, cashflow yield, and sales to price ratio also outperformed markets by at least 2 percentage point.
The market grew by 3.4 percentage points in December, however, most growth sub-factors were outrun. Investment Metrics found that stocks with high earnings and sales growth lag the market by 70 base points and 120 bases points, respectively. At the same time, Decembers large interest rate rise of 6.2 percent (the U.S. 10-year constant maturity rate went from 1.42 percent to 1.52 percent) was accompanied by the strong outperformance of value sub-factors over growth sub-factors. According to our research, the spread between Value and Growth was 2.5 percent in December. This is consistent with our finding that the spread between value-growth and U.S. rates increases more than 5 percent per month.
Damian Handzy, head, research and applied analytics, Investment Metrics, said Institutional InvestorThe more interest rates rise, the greater the value [stocks] win. Value stocks suffer less from rising interest rates’ discounting effect because growth stocks are dependent on long-term profits. Handzy said that a 2021 study by his company showed that value stocks outperform growth stock’s by 100 basis points for every ten percent increase in interest rates.
Research Affiliates’ chief executive officer Chris Brightman stated that investors should prepare for high-inflation environments by allocating to value stocks in their portfolios. He stated that investors should be thinking long-term since inflation is unlikely to slow down in the near future. This is because the central banks have reached the limit of their monetary and fiscal tools to restore price stability. He said that nominal interest rates cannot rise above inflation in G7 nations due to their high debt levels during the pandemic. Brightman says that while governments have the option to raise taxes to combat inflation, they may not have the motivation to do so as sustained inflation may be the best political path to decrease excessive public debt.
Brightman stated that we don’t rely on aggressive valuation-reversion assumptions and expect value stocks to deliver long term real returns in excess of 6 percent in the U.S. and between 8-10 percent for emerging markets, European and Japanese markets. Brightman said that value stocks worldwide offer exposure to cyclical economic sectors that are likely to benefit from inflation.
According to Investment Metrics, the U.S. value stock market is an attractive investment opportunity. They also surpass benchmarks in emerging markets and other advanced 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, returns from value sub-factors ranged from 2.6 percent up to 2.8 percent. This is well above the market’s average of 2.1 per cent.
Investors are looking for a safe haven in the face of rising inflation. Value stocks around world offer an opportunity to invest. [thanks to]Brightman concluded that they had outstanding long-term real return forecasts.