The great Value rotation

The ‘value trade’ continues to do well as inflation concerns, whether you think it is transitory or real, point to rate rises and tapering of quantitative easing.

Europe is the most recent region to be hit by supply issues leading to price rises. The eurozone’s input costs rose for manufacturers and services at their sharpest rate since 2000 with input price inflation in manufacturing sitting at close to all-time highs, according to IHS Markit’s monthly purchasing managers’ survey. Energy supply issues across the region have culminated in Boris Johnson calling in the Army as panic buyers flooded UK service stations. UK Gilts have been sold off after the latest Bank of England Meeting.

The yield on US Treasuries has been rising to levels not seen since June. This follows the most recent FOMC ‘dot plot’ forecasts, which showed that nine out of 18 members of the committee anticipate a rate rise by late next year, up from seven in June. Inflation, coupled with low economic growth are the characteristics of stagflation and it was a hallmark of the rescissions of the 1970s and early 1980s.

It was in these environments that value outperformed growth as it has been recently. Value stocks are less sensitive to changes to macroeconomic conditions and have a history of emerging as the winning ‘factor’ following a recession.

The threat of stagflation

Stagflation is characterised by periods of high inflation and low economic growth. We could be heading into a period of stagflation now, with pressure on inflation, but growth benign. Stagflation was a hallmark of the economy in the 1970s and early 1980s that experienced inflation at 8%, on average, and frequent returns to recessions. This era was an immense challenge for central banks and governments as increasing interest rates to curb inflation, resulted in higher unemployment and slower economic growth.

Chart 1 - US CPI by recession periods

The threat of stagflation has returned

Now, US inflation exceeds 5% for the first time since 2008, well above US Federal Reserve’s long-term target of 2%. Markets and US Federal Reserve have so far shrugged off this concern, citing that the drivers are “transitory” as opposed to persistent, expecting inflation to “cool off”. We call this ‘inflacency’ in our recent ViewPoints – you can read that here .

The US Federal Reserve has committed to keeping rates lower for longer, though some form of tapering of quantitative easing is expected. The most recent FOMC ‘dot plot’ forecasts which showed that nine out of 18 members of the committee anticipate a rate rise by late next year, up from seven in June. The question markets are considering is what if the Fed is moving too slowly.

COVID-19 has disrupted supply chains. Companies are reporting significant input price pressures, notably higher wages, raw material prices and transportation costs. World shipping container costs have jumped over 400% in a year. These observations have surprised economists on the upside (see chart 2) as represented by Citi’s US Inflation surprise index.

The Delta variant of coronavirus has also dented the global economic recovery. August US non-farm payroll print was below forecasts and it is the first time in two years economic figures broadly have undershot expectations (see chart 3).

The combination of high inflation and lower economic growth points to stagflation.

The impact of stagflation on equity markets

The 1970s and early 1980s was the era for value investment managers. Value companies outperform when inflation and interest rates increase, as they are less sensitive to changes in macroeconomic conditions.

Given this, investors seeking to tap the current trends should consider investing in a portfolio of international value shares.

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VanEck Investments Limited ACN 146 596 116 AFSL 416755 (‘VanEck’) is the responsible entity and issuer of units in the VanEck MSCI International Value ETF (VLUE). This is general advice only, not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Read the PDS and speak with a financial adviser to determine if the fund is appropriate for your circumstances. The PDS is available here. The Target Market Determination is available here. An investment in VLUE carries risks associated with: ASX trading time differences, financial markets generally, individual company management, industry sectors, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations, liquidity and tracking an index. See the PDS for details. No member of the VanEck group of companies guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from any fund. VLUE is not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to VLUE, or Parent Index. The PDS contains a more detailed description of the limited relationship MSCI has with VanEck and VLUE.

Arian Neiron
CEO & Managing Director, Asia Pacific
VanEck

Arian founded VanEck Australia and leads VanEck's Asia Pacific business. Recognised as a thought leader and with deep experience in asset management across a range of asset classes, Arian’s passion lies in designing investment solutions and he is...

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