We see a clear advantage to leaning towards the Value style of investing this year
However, that doesn’t mean excluding technology and AI-linked shares from our portfolios, just because they’re traditionally associated with Growth, especially after they’ve been such rewarding investments over the past six months. It’s more recognising that, with inflation still sticky and interest rates higher for longer, we believe a bias towards a Value-style investing approach will be more rewarding in the current environment.
Value and Growth are just different styles of investing
Compared to much stock market jargon, the concept of Value and Growth investing styles are refreshingly clear. There’s an obvious difference between buying cheaper Value shares with higher dividends as opposed to investing in more expensive Growth shares that should repay you with future profits.
And that’s how we look at it, a clear division of how shares are valued. We don’t need to worry where a company fits, just because it’s ‘tech’ or ‘legacy-industry’ or because it’s growing profits, we’re just looking at how it’s being valued by the stock market and how that might change. So, just because we think that Value is a better way of assessing shares at the moment doesn’t say anything about our view of the growth prospects of AI – it just tells us how we might want to price the shares in those companies. For example, the shift in long-term interest rates since the start of 2022 has been enough to halve the theoretical value of a loss-making start-up with profits many years away.
Performance linkage to the economic background
The Growth style outperformed, not every year, but overall, from 2007 to 2020. That’s clearly been linked to the success of technology-driven companies and the disruptive shift of many businesses online over that period. However, as we highlighted last year when their share prices slumped as Value outperformed, we like investing in companies that are growing their profits, especially when they are attractively priced.
We believe it is crucial to understand the economic background to that period of outperformance of the Growth investment-style over Value. This was a period when that profits growth was hard to come by and when interest rates and inflation were low, in the aftermath of the Global Financial Crisis. Previously Value-style of investing had outperformed over the period 1970 to 2006, again with a few breaks such as the dot.com bubble. This period of Value outperformance was during a phase with higher average growth, inflation and interest rates. That suggests that we look at all these factors when we decide whether to shift our investment style towards Growth or Value.
Looking at the current situation we favour Value – though watch out for AI!
Factor | Current situation | Favours Growth or Value |
|---|---|---|
New Technology Disrupting existing business models opening new opportunities for companies. | Market is focused on a long-term theme (currently AI) and is happy to chase this. | Growth |
Interest rates Interest rates determine the value of future versus current profits. Higher interest rates favour Value and lower interest rates favour Growth | Short-term interest rates are still rising. Bond yields indicate interest rates will remain above the level of the previous decade. | Value |
Inflation Inflation drives interest rates and higher inflation gives opportunities for many companies to raise profits. High inflation favours Value while low inflation favour Growth. | Inflation has remained stubbornly high and the market forecasts that inflation will remain above, rather than below, central bank targets. | Value |
Economic growth Higher economic growth means companies growing profits are more common and therefore less highly prized. High growth favours Value while low growth favour Growth. | Without depending on inaccurate long-term economic forecasts, it is clear that this recovery from Covid lockdowns is faster than after the Global Financial Crisis. | Value |
Recession The Covid lockdown saw Value underperform Growth. However previous, non-Covid recessions were neutral or saw Value outperform. | The bond market is forecasting a US recession this year, with the yield on US Treasury bonds less than short-term interest rates, | Recessions do not consistently favour Growth or Value. |
That leaves us leaning into Value-style investing against the current economic background. However, we will not adopt an exclusively Value approach and will continue to hold good quality Growth managers.
