Borrowing costs

Investors turn to value stocks as borrowing costs rise for growth giants

Investors are turning away from tech stocks that fueled a decade-long surge in equities as rising borrowing costs and a recovering U.S. economy encourage a shift from the dominant growth trading strategy to value stocks.

The S&P 500 Value Index – made up of the top 100 S&P 500 stocks judged to be the cheapest based on their price-to-book, earnings-to-price and sales-to-price ratios – returned 8.6% in 2021 from March 8. , beating the 2.0% gain of the broader S&P 500 index.

In contrast, the S&P 500 Growth Index, led by tech giants Apple Inc., Microsoft Corp., Amazon.com Inc., Facebook Inc. and Alphabet Inc., fell 3.8% over the same period. . The index is made up of stocks in the S&P 500 that achieve the strongest growth in sales and benefit from a high ratio of change in earnings to price.

The change in investor appetite is brutal. In the wake of the 2008-2009 financial crisis, the low interest rate environment created by central banks encouraged technology companies to resort to debt to drive growth. This business model of relentless investments to grow and ultimately generate returns has attracted investors despite companies losing out for years. Companies like Amazon and Facebook have finally proven they can turn a profit.

But with the yield on 10-year Treasury bills in 2021 dropping from 0.94% to 1.59% as of March 8 – suggesting that borrowing costs are on the rise – investors are now turning to companies and sectors that offer better immediate value.

“Investors now seem a bit wary of ‘jam tomorrow’ growth stocks and seem to prefer ‘jam today’ companies,” said Russ Mould, chief investment officer at AJ Bell, noting that companies that have been impacted by the pandemic offer the best short-term recovery potential.

The S&P 500 Growth Index, heavily weighted to the information technology sector, followed by consumer discretionary and communication services, generated an annualized return of 15.8% in the decade ending March 8. In contrast, the value index – focused on financials, healthcare and equity industries – lagged 10.9%, meaning value investors would have been better off after the broader S&P 500, which lagged. reported 13.6% over the same period.

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The long-term underperformance of value sectors is now another attraction for investors as economic growth picks up.

“These stocks have generally performed worse not only over the past year but also over the past decade, so they might just offer faster growth at a much lower valuation,” Mold said.

Recovery for growth stocks

Growth stocks’ declining fortunes are exemplified by Tesla Inc. The electric-car maker has become the seventh-largest company in the S&P 500 with a market capitalization of $540.4 billion as of March 8, though it does not only made a profit in fiscal year 2020.

The extraordinary investor backing in the face of such subdued financial performance means the automaker has a present value between price and book value – a key measure of market valuation – of 24.3x as of March 8. In contrast, financial companies such as Warren Buffett’s Berkshire Hathaway Inc. and JPMorgan Chase & Co. – the two largest constituents of the S&P 500 Value Index, which sit on opposite sides of Tesla in the ranking of the market cap – have price/pound values ​​of only 1.35x and 1.87x, respectively.

But fortunes change. Tesla’s share price has fallen 30.6% to March 8 from a high of $883.09 on January 26, as a rise in Treasury yields warns of higher borrowing costs for companies that consume money. Berkshire Hathaway and JP Morgan stock prices are up 11.1% and 20.3%, respectively, in 2021 so far.

“The driver of the latest equity market rotation has likely been rising government bond yields, which affect some of these sectors more than others,” wrote Thomas Matthews, market economist at consultancy Capital. Economics, in a March 4 research note. “We doubt the rise in real yields will continue. But even if we are right about that, we believe the stock market rotation will continue as the global economy returns to something more normal.”

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The return to value stocks is reminiscent of the early 2000s. The tech bubble that burst and burst at the turn of the millennium was followed by a rotation into value stocks that lasted from 2004 to 2008, when the financial sector was devastated by the financial crisis.

Although the tech bubble has not burst this time around, stretched valuations for tech stocks are encouraging investors to move elsewhere.

“Despite the nascent outperformance of value names, they still remain relatively cheap,” BCA Research economists wrote in a March 5 research note, adding that the valuation gap between value stocks and growth is now greater than “the height of the Internet bubble”. .”

But the longer-term outlook for growth stocks, especially technology, is good assuming inflation remains subdued and the Federal Reserve refrains from significantly tightening rates.

Value stocks should be in a good position in 2021, while technology will likely see poor performance in the first half of the year, said Joachim Klement, analyst at investment bank Liberum. The technology, however, is set to return in the second half of 2021, Klement said.

“2022 should also be a good year for value stocks and a tricky one for tech stocks due to inflation headwinds,” Klement said. “However, once this hurdle is cleared, we expect inflation to stabilize again and tech stocks to do well over a three- to five-year horizon.”