Why We Think Now Is a Good Time to Invest in Value Stocks
Economic and financial market conditions in the 10-15 years before the COVID-19 pandemic proved unusually friendly to investments in growth stocks.
The pandemic’s fallout has ushered in an era of high inflation, warranting substantial interest rate increases that have dramatically altered the investment landscape.
Value stocks have historically outperformed during inflationary environments.
Central Bank Policy Influences Equity Style Outperformance
As the world faces coronavirus variants, long COVID and the pandemic's ongoing economic and societal fallout, many yearn for a return to “normal” life. But for global investors, what passes for normal may defy explanation — an apt narrative for financial markets since early 2020.
Equity investors are struggling to adapt to an economic environment many may have forgotten or never experienced. Central banks are actively trying to reduce high inflation. Against this backdrop, we think it’s appropriate to consider the types of equities that performed well before this bout of surging prices and those that have historically outperformed in periods of high inflation and rising interest rates.
In our view, it’s also important to review what equity investment styles have worked well in the long term, regardless of economic, geopolitical or other timely events driving short-term returns.
Easy Money Benefits Growth Stocks
In the wake of the financial crisis of 2008-2009, growth stocks benefited from a prolonged period of global central banks’ accommodative monetary policy. As shown in Figure 1, this policy tailwind helped propel growth stocks to outperform value stocks during most of the 15 years leading up to the pandemic in 2020.
Figure 1 | Growth vs. Value: Years of Pre-Pandemic Outperformance
Data from 12/31/1978 – 9/30/2022. Source: FactSet. Returns in USD. The green-shaded area represents periods when value outperforms growth. The yellow-shaded area represents periods when growth outperforms value. Data represents the difference between the MSCI World Value Index and the MSCI World Growth Index. Excess return, in investment management literature, is used in risk-adjusted return discussions and risk-adjusted return calculations, such as the Sharpe Ratio. It equals the return of a portfolio minus the return of what is considered to be a relatively risk-free asset, such as a U.S. Treasury bill. Past performance is no guarantee of future results.
The pandemic initially pushed all stocks dramatically lower. Growth equities regained their footing relatively quickly and resumed their outperformance after equity markets hit their pandemic lows on March 23, 2020. From that low point through November 22, 2021, global growth stocks surged 114%, compared with 95% for global value stocks.¹
During that period, interest rates remained historically low while sovereign governments unveiled unprecedented fiscal stimuli designed to safeguard the global economy from calamity.
Value Stocks Tend to Benefit When Monetary Policy Tightens
Sentiment shifted in late 2021. Investors began recognizing that the rising inflation the Federal Reserve (Fed) deemed “transitory” would likely not abate as quickly as expected. Equity markets lost steam as investors contemplated the need for global central banks to raise interest rates to help quell inflation. Since November 22, 2021, global growth stocks have dropped 28%, compared with a 4% decline for global value stocks.²
The switch in equity market outperformance from growth to value fits the historical trend of value outperforming after central banks cease accommodative monetary policy programs—e.g., after the Fed aggressively raised rates to fight inflation in the early 1980s and to cool the housing market in 2004-2007.
Equities tend to struggle somewhat in a rising-rate environment. When their returns decline, dividend yields are typically more pronounced in value stocks, emphasizing their importance in overall equity returns. See Figure 2.
Figure 2 | Importance of Dividend Yields in Low Return Environment
S&P 500®: Dividends’ Contributions to Total Average Annual Return by Decade
Data from 1/1/1940 – 12/31/2021. Source: Morningstar. *Note that the 2000s had negative total return; dividends provided 1.8% over the decade. Performance in USD. Past performance is no guarantee of future results.
More Than a Short-Term Solution
Despite the immediate outperformance of growth stocks after equities reached their pandemic lows, value stocks still have outperformed growth stocks since the market bottomed in March 2020. That’s not an unusual phenomenon. Value has outperformed growth for much of the past century.³
In Some Cases, Higher Potential Rewards Don’t Require More Risk
In one respect, value’s long history of outperformance might seem counterintuitive. Many investors presume the highest-returning stocks must also carry the highest risk, as investors must seemingly “require” those rewards as compensation for the risk they might incur. And investors traditionally associate higher risk and higher rewards with growth stocks.
During the year ended September 30, 2022, low volatility stocks fell -12.7% compared to a 29.9% decline for high volatility stocks.⁴ That dispersion is not unusual. In addition to strong balance sheets, higher dividend yields and attractive market valuations, low volatility is a critical characteristic professional money managers seek in the stocks they select for value-oriented portfolios.
Bottom Line – Value Stocks Appear Attractive Now and Long Term
In the short term, the global economy has entered a monetary policy period and a coinciding economic environment that have typically proven beneficial to value stocks and value-oriented portfolios. Likewise, the conditions that provided tailwinds to growth stocks since the end of the global financial crisis have largely disappeared.
History has shown that consistently owning value stocks has delivered long-term benefits without courting undue risk. These benefits have accrued regardless of short-term policy and economic variations.
Data from 3/31/2020 to 11/22/2021. Source: FactSet. Performance is based on Standard & Poor’s Global Growth and Global Value Indexes.
Data from 11/22/2021 to 11/22/2022. Source: Morningstar Direct.
Source: American Century Investments, Fama-French factor returns for the U.S. chart shows the cumulative High Minus Low (HML) factor return from June 1926 to June 2022 (June 1926 = 100) defined as the average return on the Small Value and Big Value portfolios minus the average return on the Small Cap and Big Growth portfolios. Past performance is no guarantee of future results. https://mba.tuck.dartmouth.edu/pages/faculty/ken.French/data_library.html
Data as of 9/30/2022. Source: FactSet, Merrill Lynch. High volatility stocks are defined as those in the top 20% of the Russell 1000 Index based on beta. Low volatility stocks are those in the bottom 20% of the Russell 1000 Index based on beta.
©2023 Standard & Poor's Financial Services LLC. The S&P 500® Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.