Value vs Growth – regime change or
Obviously, we’ve all been a witness to the massive outperformance of the Growth over Value investment styles over the last few years, further exacerbated by government’s policy response to the virus in 2020. However, in 2020 we also witnessed the biggest fiscal policy response we’ve seen since the last World War. That fiscal response is likely to continue into 2021, especially with Democrats in the US having the presidency and both floors of parliament. Does that mean we finally start see some inflation? Or is inflation really dead? Or for that matter, is Value dead?
With that, it’s worth noting the following:
1. Historical market direction following downturns / recessions,
2. Historical market direction following changes to inflation,
3. Likely market direction following on virus re-opening.
On point 1, history has shown that Value outperforms Growth following recessions and/or big market downturns. That’s because Value stocks tend to benefit more from strong surges in economic growth in addition to high levels of fiscal stimulus. This time might be different given this isn’t your traditional downturn/recession, but the history is worth noting.
On point 2, whilst inflation remains very low right now and there’s likely a long way to go before we have to worry about any serious levels of inflation, the market reacts to inflation changes on a forward-looking basis. As such, whilst actual inflation is important for the economy and central bank decision making, its inflation expectations (not actual inflation) that are the focus of markets. More recently, inflation expectations have been rising, and especially so in the last couple of weeks given the Democrat clean sweep of the US House, Senate, and Presidency, which is therefore likely to lead to a significant increase in fiscal stimulus. At the same time, there’s a massive fiscal stimulus package coming through in Europe, and you’ve got central banks not taking their foot off the monetary stimulus pedal. That amount of stimulus should be highly inflationary (unless my university degree was a waste of time!) at some point in the future.
The critical question then is, when will it be inflationary? Before that happens, inflation expectations begin to rise. Then bond yields begin to rise. When this happens, this is generally a positive signal for Value over Growth investment styles. The other critical question at this point is how far will central banks let government bond yields rise considering the huge and ever-increasing government deficits and debt loads that need to be financed with new borrowings? If bond yields rise strongly, then Value significantly outperforms Growth. If bond yields rise a little before the central bank steps in and does more QE, then both Value and Growth can perform well. At this stage, we just don’t know. But history tells us that rising inflation expectations (and then inflation) is good for Value and bad for Growth.
On point 3, a little bit of this is covered in points 1 and 2, but point 3 is unique because we don’t have too many post pandemic data points to look at. At this stage, it looks likely that both Value and Growth stocks and investment styles should win this year given the significant amount of fiscal and monetary policy currently in the system and still yet to come. That money needs to find a home somewhere and given how low returns are on cash and bonds (likely to continue in the foreseeable future), it’s highly likely to find its way into growth assets like equities, property, and infrastructure. If that same money wants to find a positive real rate of return (i.e., net of inflation), then it must go into these assets.
However, that view assumes everything in play at present largely goes to plan – i.e., the fiscal stimulus comes through; the central banks keep providing stimulus; vaccines are successful, widely distributed, and widely taken up; no further significant lockdowns and economies re-open. If there are any missteps in any of these assumptions, then Value and Growth will diverge, and the outcomes will be very different.
Lastly, it is worth noting that over the medium to longer term, it’s highly likely the market environment that we had pre-virus continues for some time into the future – i.e., low rates of economic growth, low levels of inflation, low levels of interest rates, poor demographics, etc. If this is the case, then Growth continues to beat Value over the medium to longer term, but by a lesser degree than it has over the last 3-5 years. This is largely consensus. However, if the provision of both fiscal and monetary stimulus at the same time and in significant volumes is enough to shake us out of that environment (i.e., inflation, higher bond yields, sustained higher levels of economic growth), then the medium to longer could look very different to current consensus.
2021 is likely to be a juncture.
Right now, binary positioning in portfolios (i.e., Value or Growth) is very dangerous. It pays to have both, whilst the case for cash and bonds becomes more difficult considering the very low rates of return on offer. 2021 should be a strong year for equities, property, infrastructure, and corporate credit. We think equities, particularly Asian & emerging markets, and infrastructure will be the standout.
Value vs Growth Review has been written and published by Insight Investment Services.
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