People like us – fiduciaries who manage other people’s money all day long – spend a lot of time with charts and spreadsheets. We run what-if scenarios. We say things like, “Look at that! Do you see the inflection point? What did the performance look like 6 months before that? Over 10 years? Over only a week?” We love to find meaningful data points, especially when we can match the context of those data points to a result in investment performance.
This is why 2021 and now 2022 have been a fascinating time to manage money.
We do love a chart that just keeps going up and to the right just as much as the next guy because, well, we are investors ourselves and we like to deliver results to our clients. The last two years have seen a lot of “up and to the right,” especially in certain parts of the market. Large cap growth – which includes big tech companies like Amazon and Google that investors seemed to gobble up – was an obvious place to make money in 2020 and 2021, even for brand new investors.
In recent years, three stock market trends have been unusually persistent:
- Large cap stock outperforms small cap stock
- Domestic stock outperforms international stock
- Growth stock outperforms value stock
In a “normal” five-year stretch, an investor would expect these trends to switch places regularly, especially between growth and value stocks. Growth stocks would outperform value stocks for one or two years, then value stocks would outperform the next year. But over the past five years, we have seen growth consistently outperform value. Until 2021.
In the first quarter of 2021, large cap value beat large cap growth handily (value: 11.26%, growth: 0.94%, a difference of 10.32%). Growth then caught up and beat value, with the two investment styles performing similarly for the full year in 2021. However, in 2022, with the Fed’s major acceleration in interest rate increases, value stocks have taken a pronounced lead over growth stocks.
What’s the connection between rates and how growth performs? Very low interest rates are good for growth companies because borrowing costs are low. As rates rise, so do borrowing costs, which may stymie growth companies by making them less profitable or hesitant to borrow money. Interest rates also play into how companies are valued, with increased rates lowering the value of future cash flows, especially when they are expected far out in the future as with most “growth” companies.
As you can see from the charts below, the Fed’s announcement in March to raise rates much more aggressively than previously expected caused an immediate inflection point between the performance of growth and value stocks. Follow the performance of growth (blue) and value (green) over 10 years, 3 years, 1 year, and year-to-date to see how this plays out.
10 Years: Value and growth used to trade places as market leaders.
3 Years: Growth is the market leader over value by a long shot.
1 Year: Value and growth trade places, but value leads as growth falls due to the Fed’s aggressive interest rate policy.
2022 YTD: Value leads growth by an enormous margin as the market progresses through its transition to higher rates.
The financial markets are clearly in a moment of transition, a distinct inflection point as investors decipher what higher interest rates will mean for consumer spending, wages, prices, the supply chain, revenue, expenses, and profit. The future is very uncertain right now, and financial markets do not like uncertainty.
This year the bond market has not been able to provide its traditional hedge against stock market declines, but value stocks have certainly been a buoy for portfolios that also hold growth stocks. As the markets begin to digest the possible outcome of increasing rates, we should see the disparity in the returns of growth and value stocks decrease. If interest rates land in a more traditional range of 2-4%, that could pave the way for value stocks to provide returns that are more comparable to their growth peers over a long market cycle. The future positive result could be that investors have a more diverse set of assets that can help them meet their goals. As fiduciaries who manage long-term portfolios, we favor diversification because it gives our clients more opportunities to win and lowers the risk of being overconcentrated in one part of the market – especially if that part of the market has a misstep.
If you need help figuring out if your portfolio is aligned with your financial plan, or if you just want to spend some time with friendly financial nerds, give us a shout at firstname.lastname@example.org.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.