Rising rates, inflation, and value investing. Director of Portfolio Research John Forelli, CFA, discusses these trends and how they’re shaping up in 2022 in the latest Entry Points For questions or additional information, please contact us.
Inflation, Rising Rates and the Return of the Value Cycle
Catalysts in Play: Marketwatchers for some time have been monitoring the inflationary backdrop to predict whether and when the Fed may adopt a more hawkish stance. As we near the end of the first quarter, it comes as no surprise that the Fed has indeed indicated it will be raising rates as early as March and begin selling bonds later this year. This shift in monetary policy adds a new dimension that should have widespread ramifications across the market and likely unseat many of the winners from the recent past.
Entry Points: The shift, of course, is not unprecedented. To get a sense how these new dynamics may influence equities, history can provide some color. While 10-year bond yields have largely maintained a downward trajectory for over 40 years, prior to this prolonged stretch, value equities steadily outperformed growth from 1954 to 1981. The same scenario, from approximately 2002 to 2007, again played out as a rising yield environment again coincided with value outperformance.
Multiple Compression: As the cost of capital escalates, it becomes harder for investors to model growth out into the foreseeable future. A factor behind value’s outperformance during inflationary periods and eras marked by rising rates is the multiple compression that occurs parallel to rising costs. Going back to 1950, price-to-earnings multiples were at their highest when inflation ranged from zero to 2%, but contracted by nearly four turns – from 18.6x to 15x earnings – whenever inflation exceeded 4%. This tendency is already evident as 10-year bond yields have increased amid growing inflation expectations.
Evolving Appetites: Of course, some sectors tend to be more sensitive to rising rates and inflationary pressures. In particular, traditional growth industries such as technology and telecom have historically lagged areas of the economy associated with value, including financials, energy and industrials. As investors begin to discount future earnings, longer-duration equities tend to be more exposed as valuations are adjusted downward.
Active Strategy: As of March 2022, growth companies were trading at premiums ranging from 50% to 100% above historical median valuations dating back to 1982, based on capitalization and style. Value stocks, alternatively, were trading at a smaller 17% premium relative to history. Given that the inflationary cycle appears to be in the early innings, particularly as geopolitical tensions add new variables, Boston Partners active approach to value investing guided by an integrated investment process that can identify high-quality companies at attractive prices, while exhibiting positive business momentum — can deliver performance during periods of rising rates as well as across various economic and market environments.
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Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940. Registration does not imply a certain level of skill or training. The views expressed in this commentary reflect those of the author as of the date of this commentary. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Past performance is not an indication of future results. Discussions of securities, market returns, and trends are not intended to be a forecast of future events or returns.