Growth vs value in an inflationary world
This year marks the first time since the pandemic started that central bank support for the economy will start to wind back, heralding a new era for equity markets and potentially shifting the focus of investors from growth to value stocks.
Even with the uncertainty generated by Russia’s invasion of Ukraine, the US is still expected to begin raising rates shortly. Talk of the Fed’s move to tighten conditions has already sparked a rocky start to 2022 in the tech sector, the classic home of growth stocks, experiencing a sharp selloff in January.
In Australia, the Reserve Bank confirmed the end its bond buying program in February, which had been an important support to the economy by reducing funding costs, supporting asset values, and weighing on the exchange rate.
But importantly for the growth-versus-value stocks debate, Reserve Bank Governor Philip Lowe says the uncertainty of the situation in Ukraine, which has muddied the economic outlook, only added to the bank’s caution over raising rates.
The RBA significantly missed its major economic forecasts for 2021 making it much more guarded about predicting its next rate move while it waits to assess economic conditions.
In its latest statement on Monetary Policy, published on March 1, Dr Lowe said the bank “will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. While inflation has picked up, it is too early to conclude that it is sustainably within the target range.”
Dr Lowe has stated on several occasions now that while there was a plausible scenario for a first rate hike this year, there was an equally plausible one that a first rate hike is a year or further away.
One thing he continues to make clear is that the RBA believes the economy is very resilient and on track for a good 2022 with 4.25% growth forecast and with unemployment set to fall below 4.0% - both positives for driving demand in the economy.
Value and growth investing are seen often as opposing strategies. Value investors seek to profit as a share price returns to its “fair value" level, while growth investors are looking for "winners" and pay up for earnings expected to be delivered in the future.
With interest rates low and central banks pumping money into the system, growth investors have had a field day.
Now, with the likelihood of less central bank support and the prospect of interest rate rises, the focus would normally shift to value stocks, whose prices may not reflect their true performance.
Amid the consequences of pandemic lockdowns, these might include shopping centres, office trusts and airlines. Carbon-based energy stocks that have been hit by growing investor concern about emissions and climate change. Or, interest rate-sensitive stocks such as insurers who can struggle to make returns on their bond portfolios.
While it is too early to say whether the future is totally on the side of value investors, the market has seemingly made an early call.
The S&P/ASX 200 Info Tech (ASX: XIJ) has slumped 20.5% year to date (March 2), while the S&P/ASX All Technology Index (ASX: XTX), the benchmark for Australian tech companies, has slipped 19.4%.
Some big market players have also shifted.
GQG Partners Inc (GQG) co-founder and chief investment officer Rajiv Jain told investors: “We have already seen some cooling and signs of cracks in the latest round of earnings results for several technology and consumer discretionary companies.
ASX-listed GQG – which tries to tread a path between value and growth investing - told investors in a fourth quarter commentary: “As the dynamics in these sectors begin to shift, we believe it will have major implications for the market as a whole. Therefore, rather than ignore the potential storm ahead of us, we have chosen to prepare for the possible winter.”
As a result, GQG funds have begun to position for the shift away from high growth stocks.
Corporate performance in focus
But before making the shift entirely out of growth stocks it may pay to keep an eye on company performance. As with everything post-pandemic, things may not be as simple as they once were. The new environment will require equity investors to be far more selective.
In this new world the quarterly reports from companies, especially in the growth sectors that have benefitted from easier monetary policy, should be closely watched.
The good news is that, for both growth and value investors, stockbroker forecasts for S&P/ASX 200 company earnings for the 2022 financial year stand 10 per cent higher than December 2019 levels.
If these analysts are right, earnings by June 30, this year will more than compensate for the contraction experienced since the pandemic began.
Though here again it pays to be cautious.
Australian blue-chips saw a 26 per cent surge in in earnings per share in fiscal 2021, so this year’s forecast of a 13.6 per cent gain is actually a big slowdown, according to consensus estimates measured by Morgan Stanley.
And most equity strategists are expecting the winners and losers to be more difficult to spot compared with 2021.
The latest earnings season has confirmed the strength and resilience of the traditional sectors of the economy like mining, resources and banking, and revealed some recovery is in sight for the sectors hit hard by the Covid pandemic such as travel and aviation.
Earnings upgrades have also outnumbered misses by a ratio of 4:3, and overall earnings growth projections rose by 2 per cent, with 14 per cent profit growth expected for the ASX 200.
New options emerge
The performance of some ETFs targeting value stocks could indicate a switch is under way. The Vanguard Global Equity Active Value Equity ETF (ASX: VVLU), which invests across 1243 large, medium and small companies in developed markets, returned 39% for the past year, against 24.56% for its benchmark. The fund was launched in 2018 and has A$330 million under management.
The VanEck MSCI International Value ETF ASX:VLUE) launched in March 2021 has attracted A$133.6 million and posted one, three and six-month returns in line with the MSCI World ex Australia Enhanced Value top 250 Select index.
With the macro economy seemingly on a solid path to growth, albeit facing interest rate rises in the future, a simple switch from growth to value stocks may not be the right answer. More than ever it may be down to stock section and sector picks.