PM Perspectives: Value May be Poised to Outperform Growth as Rates Rise
Justin Tugman, Co-Portfolio Manager of the Perkins Small Cap Value, Mid Cap Value and SMID Cap Value strategies, says nine years of significant outperformance for growth stocks may be coming to an end as rising interest rates and increasing inflation expectations tilt in favor of value stocks.
- Financials, industrials and materials, and energy may be well placed to benefit as the pendulum swings in favor of value stocks.
- Valuations in sectors such as health care, technology and consumer discretionary are less attractive.
- Reduced regulation and lower corporate taxes favor domestically focused small-cap and mid-cap stocks.
When you look over the past decade, you have seen significant outperformance of growth, primarily led by tech stock such as Amazon, Netflix, Google. We do think that cycle is about to reverse, and it sets up very well for value going forward.
It has been a great run from the market bottom in 2009 for growth stocks, but we think valuations are now elevated and that they favor value over growth stocks.
When you do encounter low interest rates, you are typically in an economic environment that is more challenged, where you are seeing less growth and investors are willing to pay up for companies that are growing. We think now, though, as the central banks begin to normalize their interest rate policy due to a more sustained and higher level of economic growth, that sets up well for value. Inflation should be a beneficiary to value over growth. It will likely lead to higher interest rates, but when you have gone through the past decade, inflation has been almost nonexistent, and that has led to a period of significant outperformance for growth stocks. Now that you are starting to see inflation beginning to accelerate in the U.S. and around the world, it should be a driver of higher interest rates, which sets up very well for the value stocks, whether it is the financials or those inflation hedges in the commodity-exposed names, whether it be materials or energy.
Within the value benchmarks we typically find higher exposure to things like energy and commodity-exposed names, kind of the old economy names. We will find that the growth benchmarks have a lot more names in health care, consumer discretionary and technology. We think those are some of the areas where the valuations are less attractive.
We are very optimistic on both small and mid caps. When you look at some of the policy changes that have come out of D.C., whether it has been on the regulatory front, it has been changes on tax law, we think being domestically exposed is a very good place to be going forward, given that government has cut a lot of red tape and made it a much more friendly business environment over the next few years,. The regulatory burden has had an outsized focus on the financial sector, really since the 2008 to 2009 time frame, coming out of the financial crisis. We think those are about to ease going forward, and it sets up very well for the smaller financials within the banks and some of the other areas that are very heavily regulatory exposed.
We believe it is very important to be positioned in high-quality, defensive-oriented companies. We have had a terrific run in this market, going back to 2009. The S&P has almost quadrupled off the March 2009 lows. A lot of gains have been made in this market, and now with valuations becoming lofty, we think it is important to hold on to those hard-earned gains. You want to start to focus on those names that will provide more defensive exposure. Whenever we do get a sell-off in this market, it is going to happen, we do not know exactly when, but you want to be prepared for that, and while you can still certainly be invested in equities to participate, if there is further upside, we think it makes sense to have a defensive bias to hold on to those gains you have achieved over the last decade.