(Updated January 2023)
CHART: Value’s Back – Russell 1000 Growth and Value: YTD22 P/E Contraction
Looking for a sign that value is back? Look no further than rising interest rates and elevated inflation focusing investors on the value comeback underway.
Led by the Federal Reserve, the tightening of monetary policy from the “free money” programs has clearly been one of the most impactful changes. Inflationary pressures last seen in the 1980’s from higher energy prices to supply shortages have forced the Fed to reverse its policies and raise interest rates significantly in an effort to lower inflation, even in the face of a potential recession. This is in sharp contrast to the past several years, which saw interest rates hit 5,000-year lows, with the recent move higher just now bringing interest rates back to the more normal levels seen over the last 30 years.*
Given the market is a discounting mechanism, higher interest rates will negatively impact current valuations, no matter the investment style. Mathematically, as the interest rate rises, future cash flows are worth less today as they are discounted back to the present. The farther in the future and the greater the amount of the cash flow, the more meaningful the impact from higher rates. Valuation multiples are a simple way for investors to quantify the discounting of cash flows for a security: as rates rise, valuation multiples will decline, all else equal.
Businesses with high growth rates forecasted many years into the future previously traded at extreme multiples, leaving them far more susceptible to the pressure of even small interest rate increases which dramatically affect their valuation multiples. Compared to businesses with more consistent, near-term cash generation, future cashflows have a less meaningful contribution to their valuations and thus, moderate the impact of rate increases. While overly simplistic, this difference is an important contributor to the difference in multiple compression seen between growth and value this year. With valuations of value stocks now trading below long-term averages, the market appears to have discounted higher interest rates into current prices and may represent a lower-risk entry point for value compared to growth, which is still trading at a premium.
View Full Report: Value’s Back…And It’s Only Just Begun
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All opinions included in this presentation constitute Barrow Hanley Global Investors’ (“Barrow Hanley”) judgement as of the time of issuance of this presentation and are subject to change without notice. This article was prepared by Barrow Hanley with information it believes to be reliable and is for informational purposes only and is not intended to be an offer, solicitation, or recommendation with respect to the purchase or sale of any security, nor a recommendation of services supplied by a money management organization. Barrow Hanley is a value-oriented investment manager, providing services to institutional clients. This article includes certain "forward-looking statements" including, but not limited to, Barrow Hanley's plans, projections, objectives, expectations, and intentions and other statements contained herein that are not historical facts as well as statements identified by word such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "projects," or words of similar meaning. Such statements and opinions contained herein are based on Barrow Hanley's current beliefs or expectations and are subject to significant uncertainties and changes in circumstances, many beyond Barrow Hanley's control. Actual results may differ materially from these expectations due to changes in global, political, economic, business, competitive, market, and regulatory factors.
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