Growth Or Value As Interest Rates Rise? by Robert R. Johnson, PhD, CFA, CAIA
President and CEO of The American College of Financial Services
Now that the Fed has raised the target Fed funds rate for the first time in nearly a decade, pundits have switched their attention from speculating on if a rate change was going to take place to what the rate change means for the financial markets. Many analysts are speculating on which investment style and which equity sectors will be the winners in the new, higher interest rate environment. For instance, in a recent MarketWatch piece, Tim Clift contends that “growth stocks are your best bet as interest rates rise,” and that “signs favor technology and consumer discretionary sectors.”
While I certainly don’t have a crystal ball, I can provide some insight into which styles and sectors have performed best in the past when interest rates were rising. And, Mr. Cliff’s selections are certainly inconsistent with past performance.
David Einhorn Buys Three New Stocks: These Are The Names And Theses (Q3 Letter)
David Einhorn's Greenlight Capital funds returned 5.9% in the third quarter of 2020, compared to a gain of 8.9% for the S&P 500 in the same period. This year has been particularly challenging for value investors. Growth stocks have surged as value has struggled. For Greenlight, one of Wall Street's most established value-focused investment funds, Read More
In Invest With the Fed, my co-authors, Gerald R. Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University and I examined how different asset classes, investment styles and equity sectors fared during rising, flat, and falling interest rate environments. There is obviously no guarantee that future performance is going to be consistent with the past, but there have been clear patterns in returns with respect to directional changes in interest rates.
Our overarching finding was that the broad equity market performs dramatically better when rates are falling than when rates are rising. From 1966 through 2013, the S&P 500 returned 15.2% when rates were falling and only 5.9% when rates were rising. When you factor inflation into the equation, the real return was 12.3% when rates were trending downward and a paltry 0.8% when rates were trending upward.
Value clearly beat growth in falling rate environments. Using price to sales as a proxy for value, and sorting stocks into quintiles, value stocks returned 28.1% versus 13.8% for growth stocks when rates were falling. When rates were rising, neither style performed particularly well; value returned 5.0% and growth only 4.1%. The bottom line for investment style is that given the current rate environment, we believe both growth and value investors would be well served to revise their return expectations downward.
As for sectors, the best performers in a rising rate environment were defensive stocks – energy, utilities, food, and consumer goods. Other sectors that were solid performers were precious metal miners and financials. We found that consumer discretionary sectors – automobiles, retail, durable goods, and apparel – have been among the worst performers when rates were rising. In fact, automobiles and durable goods actually had negative absolute returns during rising rate environments, while apparel and retail had negative real returns.
Whether Mr. Clift is correct, or history holds form is an empirical question that will be answered over the next few months and years. But, if I was a betting man I know where I would place my wager, as the four most dangerous words in the English language with respect to investments is “this time is different.”