The combination of high inflation and higher rates has had a negative impact on the equity markets this year. But value sectors have fared relatively better overall in 2022, despite a rebound in growth in July. Until inflation falls more sustainably, we favor investing in value with a quality tilt, energy stocks, and the UK market. We think growth-oriented parts of the market are set to underperform.
Modest GDP growth, low bond yields, and persistently below-target inflation, combined with technology adoption, were fundamental tailwinds for growth stocks throughout the last cycle. But equities are now navigating a different and more challenging backdrop, with stubbornly high inflation, rising interest rates, and slowing growth.
While cyclical sector valuations have begun to reflect these concerns over the course of 2022. As of 28 July, the MSCI World Growth Index is down 22%, versus a fall of just 9% for the equivalent value index – even following an outperformance by growth in July. But despite their weakness in 2022, growth stocks are not yet attractive enough in our view. Even with recent pressure on the tech sector, growth still commands high premiums over value.
We instead recommend investors tilt more of their portfolio away from growth stocks and into value and defensive sectors to better withstand slowing economic growth. Value should perform particularly well in our “soft landing” scenario, where increased confidence in the resilience of corporate earnings would support some of value’s cyclical sectors.
We recommend three broad strategies to benefit from this:
- Historically, periods of rising inflation and rising bond yields have been associated with value outperformance, especially during expansions and recoveries.
- After a long period of weak relative performance, we expect economic conditions over the next few years to support outperformance by value stocks.
- We see four catalysts for the energy sector to outperform: economic reopening, persistently high oil prices, share buybacks and dividends, and earnings growth and net earnings revisions.
- We also like the UK market, given its exposure to more value-oriented sectors, and its current discount against its historical average.