The Benefits of Value Stocks in Rising Rate Environments
As investors flock to safety, value stocks have outperformed growth stocks year-to-date amid economic turbulence and rising interest rates.
Owing to their strong fundamentals and cash flows, value stocks may be returning into favor.
In this infographic from New York Life Investments, we illustrate why value stocks offer opportunities in rising rate periods.
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Recent Performance
In a matter of two years, the Ukraine war, supply chain shocks, and COVID-19 have led inflation to multi-decade highs.
Amid these complex struggles, value stocks have outperformed significantly.
- Russell 1000 Value Index: -1.1%
- Russell 1000 Growth Index: -14.1%
- S&P 500: -8.4%
As of April 14, 2022
With higher inflation predicted for the medium term, value stocks may be staging a comeback.
As investors look to de-risk their portfolios, many are turning to value stocks, thanks in part to their historical outperformance during inflationary and rising rate periods.
Value vs. Growth: Key Characteristics
As a quick refresher, here are the key distinctions between value stocks and growth stocks.
| Characteristic | Value Investing | Growth Investing |
| Defining Features | Companies with stronger cash flows, steady income, priced below intrinsic value. | Companies with lower cash flows, low (if any) income, strong earnings growth potential. |
| Valuation | Undervalued (low P/E ratios) | Overvalued (high P/E ratios) |
| Dividends | More common | Less common |
| Volatility | Lower | Higher |
| Sectors | Financials, Energy, Healthcare, Industrials | Tech, Communications, Consumer Discretionary |
Cyclical sectors such as financials and energy often benefit when prices increase after an economic contraction.
Since companies earn money in different ways, it is often useful to compare price-to-earning (P/E) ratios within a sector. A P/E ratio is a metric for valuing a company, where a company’s stock price is divided by its earnings per share.
An overvalued company in the tech sector may have a P/E ratio of 100, while the S&P sector average is 24. By contrast, an undervalued healthcare company may have a P/E ratio of 14, lower than the S&P sector average of 16.
When a company is undervalued it means that it’s trading below its intrinsic value.
Value vs. Growth: Performance
Looking back, the previous decade saw the worst performance for value in the last 90 years.
On average, growth outperformed value by 7.8% annually since 2010. However, looking at 10-year periods, value has outperformed growth over every decade since the 1940s.
| Decade | Value Outperformance |
| 1930s | -0.5% |
| 1940s | 10.8% |
| 1950s | 5.6% |
| 1960s | 4.2% |
| 1970s | 8.1% |
| 1980s | 7.4% |
| 1990s | 0.7% |
| 2000s | 8.0% |
| 2010s | -2.6% |
Average annual performance of Fama and French (“HML”) value factor by decade.
Source: Fama & French via Mercer (Mar 2021)
Now, against economic uncertainty and other structural shifts, the growth and value divergence is beginning to change for the first time in over a decade.
What is Driving Value Stocks?
On a broader level, the following forces have driven outperformance in value stocks and growth stocks.
| Value Investing | Growth Investing | |
| Broad Market Factors |
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So how do these apply today?
In an inflationary (and rising rate) period, current earnings become more valuable and future earnings become less valuable. Typically, “value stocks” are assessed based on their current earnings while “growth stocks” are valued on their future earnings.
Consequently, inflationary periods have tended to favor value stocks and deflationary periods have tended to favor growth stocks. When prices are climbing, companies with actual earnings are potentially better positioned to increase prices and retain profit margins.
At the same time, it is important for investors to avoid value-traps, which are companies trading below value that are in financial duress. To help mitigate this challenge, active investment managers can help identify the appropriate companies.
Sign of the Times
It’s worth noting that this isn’t about value vs. growth. Instead, different styles have performed better at different times. Of course, it’s important for investors to consider a number of variables for their portfolios:
- Investment Objectives
- Time Horizons
- Volatility
- ESG Objectives
With these in mind, investors can implement the best strategies to help achieve their goals.
Article by Visual Capitalist
