By Lewis Krauskopf
NEW YORK (Reuters) – Fears of a potential economic slowdown are clouding the outlook for value stocks, which have outperformed broader indexes this year in the face of soaring inflation and rising interest rates.
Value stocks – generally defined as those that trade at a discount on measures such as book value or price-to-earnings ratio – have generally underperformed their growth counterparts over the past decade, when S&P earnings 500 were pulled by tech-focused giants such as Amazon.com Inc and Apple Inc.
That dynamic changed this year, as the Federal Reserve launched its first round of interest rate hikes since 2018, disproportionately affecting growth stocks, which are more sensitive to rising interest rates. The Russell 1000 Value Index is down around 13% year-to-date, while the Russell 1000 Growth Index is down around 26%.
This month, however, fears that the Fed’s monetary policy tightening could trigger a recession in the United States deflected momentum from value stocks, which tend to be more economically sensitive. The Russell Value Index is up 0.7% in July, versus a 3.4% gain for its growth counterpart. “If you think we’re in a recession or we’re going to be in a recession, that doesn’t necessarily work out … to the advantage of value stocks,” said Chuck Carlson, managing director of Horizon Investment Services.
The nascent shift to growth stocks is an example of how investors are adjusting their portfolios in the face of a potential economic downturn in the United States. BofA Global Research on Thursday cut its year-end price target for the S&P 500 to 3,600 from 4,500 previously and became the latest Wall Street bank to forecast a coming recession.
The index closed at 3,863.16 on Friday and is down 18.95% this year.
Corporate earnings coming into effect next week will give investors a better idea of how soaring inflation has affected corporate results, with the results of Goldman Sachs, Johnson & Johnson and Tesla among those on deck .
For much of the year, value stocks benefited from general market trends. Energy stocks, which make up about 7% of the Russell 1000 Value Index, soared in the first half of 2022, surging along with oil prices as crude supply constraints were exacerbated by the invasion of Ukraine by Russia.
But energy stocks as well as prices for crude and other commodities have fallen in recent weeks on fears a recession could sap demand.
A recession is also expected to weigh on bank stocks, with the slowing economy hurting loan growth and increasing loan losses. Financial stocks make up almost 19% of the value index.
A beat in Citigroup earnings, however, supported banking stocks on Friday, with the S&P 500 Banks Index gaining 5.76%. At the same time, tech and other growth companies also tend to have less cyclical businesses that are more likely to weather a general economic downturn.
“People pay a premium for growth stocks when growth is scarce,” said Burns McKinney, portfolio manager at NFJ Investment Group.
Earlier this week, analysts at JPMorgan wrote that they believe growth stocks have a “tactical opportunity” to make up lost ground, citing cheaper valuations after this year’s strong selloff as one of the reasons. .
Proponents of value stocks cite many reasons for the style of investing to continue its run.
Growth stocks are consistently more expensive than value stocks on a historical basis, with the Russell 1000 Growth Index trading at a 65% premium to its value counterpart, compared to a 35% premium over the past few years. Last 20 years, according to Refinitiv Datastream.
Meanwhile, earnings per share of value companies are expected to rise 15.6% this year, more than double the rate of growth companies, Credit Suisse estimates.
Data from UBS Global Wealth Management showed on Thursday that value stocks tend to outperform growth stocks when inflation exceeds 3%, around a third of the 9.1% annual growth in consumer prices. Americans recorded in June.
Josh Kutin, head of North America asset allocation at Columbia Threadneedle, believes that a possible recession in the United States next year would be mild, leaving economically sensitive value stocks poised for outperform if growth resumes. “If I had to choose one, I would always choose value over growth,” he said. “But that belief has waned since the start of the year,” Kutin said.
(Reporting by Lewis Krauskopf, additional reporting by David Randall and Ira Iosebashvili; Editing by Ira Iosebashvili and Richard Chang)