Friday, September 16, 2022
As the focus for US equities continues to be on the macro environment, and how hawkish the Fed will act to tame inflation, we think it’s a useful time to check in on the year-to-date style performance of value and growth, from a quantitative style factor lens. Factor performance is typically measured based on a long/short portfolio of long stocks (“buys”) in the top quintile of factor scores and short stocks (“sells”) in the bottom quintile. However, in order to compare factor returns to an index such as the S&P 500, a long-only approach is required. Leveraging Bloomberg’s factors, we analyzed Growth and Value factor performance based on a long-only portfolio of the top quintile of stocks in the S&P 500 over 3 different periods.
Period 1: Start of year to the S&P 500’s bottom on June 16, 2022
Stocks with strong value characteristics such as high earnings yields strongly outperformed both the broader market, measured by the S&P 500, and stocks with high growth characteristics (sales/earnings growth). The value factor’s outperformance was driven largely by investors fleeing to the perceived safety of higher yielding stocks amidst four–decade-high inflation and a rising rate environment, as well as the high concentration of energy and other commodity producer stocks in the top quintile of value factor scores amid the run-up in commodity prices due to the Russia-Ukraine conflict.
Period 2: Summer Equity Rally (mid-June to mid-August)
Over the summer the mood in the market shifted, as the “Fed pivot” narrative took hold, i.e., that the Federal Reserve would soon stop hiking rates to fight inflation and focus on supporting economic growth. The market experienced a two month rally that saw a reversal of the factor trends seen in the first half of the year. With expectations of a more dovish Fed and a ceiling on rates, equity investors bid up growth stocks given valuations are driven in large part by on the present value of future cash flows (growth stocks are expected to have higher future cash flows), and many growth stocks’ sensitivity to the business cycle.
Period 3: Post Jackson Hole Economic Symposium to Current (mid-August to Current)
Fed Chairman Jerome Powell poured cold water on equity markets (and risk assets broadly) in Jackson Hole, WY, stating that the Fed would “use our tools forcefully” to tamp down inflation, raising rates in a way that will cause “some pain” to the US economy. Subsequent economic reports showing continued strong jobs and retail activity, and a disappointing August inflation report reinforced the market view that rate hikes will continue and the Fed will need to remain hawkish for longer. While the sample period is short, the factor performance trend follows a similar path as the first half of the year, with value outpacing the S&P 500, and growth slightly trailing the broader market.
One interesting takeaway from our analysis is that while many may perceive the flight to value as analogous to a flight to quality, our analysis showed otherwise. The performance of a “quality” composite factor, composed of high profitability and low leverage factors, actually tracked much closer to the year-to date performance of the growth factor, on both a long-only and long/short basis.
What does this mean going forward? In the very near-term, we would expect the current trend of value factor outperformance to continue, given the lack of expected catalysts to change the estimated path of rate hikes. Longer term, growth factor outperformance will likely require stronger conviction that core inflation is on a steady downward trajectory, providing clarity on the timing of a Fed pause or pivot.
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All index and market data from Bloomberg.
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