Interest Rates and Growth versus Value Stocks
Fast-growing growth stocks continue to come under selling because of rising interest rates amid Fed interest hikes and recession fears.
In a rising economic environment, growth stocks appreciate much faster than value-related names.
However, if strong economic growth leads to rising inflation and sharply higher interest rates, this can hurt growth stocks that trade at high P/E multiples and valuations. Higher interest rates and sustained inflation means future profits and earnings are valued less today.
Are investors shifting from growth toward value because of the rise in interest rates?
The enclosed chart of the benchmark 10-year US Treasury yield (TNX) against a ratio comprising of the S&P Value Index (SVX) divided by the S&P Growth Index (SGX) over the past 30-plus years reveals the following:
S&P Value Index (SVX) outperformed S&P Growth Index (SGX) during 2000-2007 as yields rose dramatically from a low of 2.42% (Jun 2000) to a high of just above 8.00% (May 2007). The 10-year Treasury yield hovered just above 3.37-3.46% during the period.
S&P Value (SVX) underperformed S&P Growth (SGX) from 2007-present as rates plummeted from over 8% at the beginning of 2007 to a low of 0.554% (Sept 2020) soon after the Covid-19 pandemic-induced recession and another lower-low at 0.4391% (Nov 2021).
In the past 13 years, TNX rarely traded above 3.05-3.47%. Except for the brief period during the Covid-19 pandemic market sell-off, rates maintained a floor near 1.46-1.51% for most of the timeframe. Despite the sharp rise in interest rates since the 2020 bottom (0.55%), SVX/SGX ratio also declined, establishing a record lower low.
Since the post-war era, whenever TNX falls below 3.00-3.5%, growth stocks have consistently outperformed value stocks, returning higher returns with less volatility. Value investing, focusing on less expensive, cyclical sensitive, and low-PE multiples, has consistently underperformed its growth counterparts.
The dominant and prevailing downtrend in the SVX/SGX ratio nears an inflection point as it challenges the 2007 downtrend (black dashed line). Since the potential bottom late last year, SVX/SGX has been trending higher, suggesting value outperforming growth.
It appears growth stocks with excessively high valuations may need to fall further. Should investors restructure their investment portfolio by selling high-priced growth stocks to move into valued names as bond yields rise?
The value call may be the dominant and popular investment theme over the past two years, but is this sustainable over the intermediate-to-long term?
If the Fed pivots next year and interest rates reverse direction, and SVX/SGX fails to break out above the 2007 downtrend, can SVX/SGX retest its pivotal support at 1.46-1.51?
Future stock market returns may depend on the longer-term trend of bond yields. Will the 10-year Treasury yield (TNX) maintain above its early-2022 breakout at 3.00-3.25?
Perhaps, the sweet spot in the marketplace today is a balance of high-quality growth names, income securities, and value stocks as investors wait for the Fed to pivot and the longer-term directional trend of TNX.