One of the unintended side effects of this week’s Federal Open Market Committee meeting is that value stocks are set to outperform growth, according to research from Barclays analysts Dennis Jose, Ian Scott and Joao Toniato. They’ve noticed that the relative performance between growth and value has depended largely on changes in the yield curve, so the Fed’s mostly bullish tone should put damper on growth stories.
“In our view, the Fed’s change of opinion regarding the path of interest rates, from the March to the April FOMC meetings, was the culprit for the volatility in the performance of investment styles seen year-to-date. We believe this is because interest rates are the key driver of the performance of value relative to growth,” they write.
Interest rate: Fed opinion may be responsible for growth stock volatility
The strong correlation between interest rate and growth/value relative performance goes back to 2003, and then suddenly broke apart in late 2013 as the market started pricing in higher interest rates. When the Fed came out with a surprisingly hawkish view of the economy at the March 2014 FOMC meeting, the trend reversed. When the Fed changed its tone in April, the trend doubled back yet again. Looked at from this perspective, the recent volatility in the stock market could be the market trying to account for changing interest rate expectations, which is as good an explanation for the March tech stock sell-off as any other.
The Barclays report speculates that a positive view of the recovery makes growth stories less impressive simply because there should be more of them around, but a higher interest rate also reduces their worth because of their duration risk. Growth stocks are valued according to their (sometimes distant) future earnings, whose present value drops as the discount rate goes up.
US investors increasingly willing to look for value stocks in Europe
One recent trend is that American investors seem more willing to look for value stocks in Europe than they have been in the past. Before the crisis, outperformance of European value stocks was loosely correlated with an increase of American buying European stocks, but the effect has been much more pronounced in the last year and a half. The trend is short enough that it could be due to other factors, but the Barclays report points out that European value stocks offer a better discount relative to growth stocks than in the US.