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Financial trends: investors seek safety via Great Rotation

In the era of low interest rates, value investors felt as lonely as singletons dining out on Valentine’s night. But this investment style — backing stocks that look cheap relative to near-term earnings — has attracted quite a crowd in 2022. The rotation to value reflects the view that, as in the 1970s, such stocks do well in inflationary times.

As interest rates rose, investors cooled on growth stocks that promised future profits, and warmed to those already making — and paying out — large sums. They have sought to avoid the impact of the downturn on stock prices via some key metrics. These include low price/earnings ratios, high book value-to-price ratios and generous dividend yields.

Line chart showing Russell 1000 Growth index and Russell 1000 value index

The MSCI Europe value index — containing companies such as Shell, Novartis and Unilever — is down 10 per cent this year. That compares with a 24 per cent fall for the MSCI growth index. The Russell 1000 value index of US stocks is down by 10 per cent. That is less than one third the drop in its growth counterpart.

Line charts showing MSCI Europe Value index and growth indexes

Value indices are tilted towards energy companies and retail banks. The former have been boosted by surging fuel prices. The latter are benefiting from the rise in interest rates. For example, fatter net interest margins at NatWest are expected to produce a hefty return on tangible equity of 14 to 16 per cent in 2023.

NatWest is set to benefit from higher interest rates bar dot with bullet showing Net interest margin (5, bullets) and Return on tangible equity (%, bars)

Looming recession complicates the picture by hitting earnings and limiting future interest rate rises. NatWest’s bigger than expected provisions sent its shares down by as much as 9 per cent in October.

Despite value stocks’ recent outperformance, they are not expensive by historical standards. The price/earnings ratio of the Russell value index is close to its long-term average of 16. But the darkening economic outlook has increased the appeal of capital-preserving defensive stocks, stealing some of the limelight from the value-versus-growth trade. Cheap stocks can go on getting cheaper if they produce disappointing results.

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