By Eli M. Salzmann & David Levine
Large-cap value stocks have characteristics that could make them compelling in the current environment and beyond.
In the wake of the pandemic and in the face of geopolitical conflict, price inflation has accelerated to 40-year highs, requiring investors to make hedging away exposure to price increases more central to their approach to asset allocation and the pursuit of long-term return. As part of this general pivot in strategy, we believe that large-cap value stocks have characteristics that could make them compelling in the current environment and beyond.
Higher for Longer
Inflation moved higher in the wake of the pandemic as societies reopened and consumers accelerated their spending, supported by government payouts and massive central bank easing. Producers were unable to meet the exceptional demand, as supply chains had incurred damage and capacity reductions, while increased orientation to online purchases created the need for new infrastructure.
Although we believe supply-chain issues should ease, helping inflation pull back from recent extremes, higher prices are likely to be an ongoing issue for some time, in light of: deglobalization of supply chains in light of climate change and strategic concerns; China’s reduced deflationary impact as the “workshop of the world”; shifts in fiscal and monetary policy toward more populist priorities; and the cost pressures created by the transition to a sustainable economy.
Role of Stocks – and Value
Over time, stock investments have often provided a reasonable hedge against inflationary forces, with inflation-adjusted returns for S&P 500 averaging 7.1% since 1912, and five-year-real returns for the index advancing 75% of the time.1 However, it’s important for investors to understand the nature of their exposure to see if it is well-suited to this inflation-fighting role. Growth stocks tend to do well in low-inflation, low-interest rate environments because the latter maximizes the present value of their future earnings potential. However, this higher “duration” increases their vulnerability when rates are likely to rise, even as their lower economic sensitivity limits their leverage to the growth that may come with rising prices.
In contrast, value stocks are often more exposed to the economy, allowing them to capitalize on the cyclical growth that typically accompanies inflation. That said, their lower valuations can make them less vulnerable to earnings disappointments than growth stocks. In addition, a substantial portion of value stocks is in commodity sectors like energy or metals, which are typically direct beneficiaries of inflationary environments. Moreover, dividend stocks are a key component of the value universe, and the regular income they generate quarter-to-quarter translates into a shorter-duration profile that is less vulnerable to rising rates.
Large Cap Value at Neuberger Berman
We believe that targeting investments that appear inexpensive relative to normalized earnings, means investors are less likely to be overly focused on recent earnings tailwinds but rather consider them in relation to the entire economic cycle. Moreover, we favor investments with a catalyst for “normalization” to occur, so we are not overly dependent on macro trends for potential results. Our value philosophy also includes focusing on companies in industries that are starved of capital and capacity; given that inflation, by definition, happens when there’s more demand than supply, we are finding even more attractive opportunities today. Indeed, it’s no coincidence that we are seeing many companies with increased pricing power in this environment.
Today, we see attractive opportunities across an array of sectors that are presenting attractive prices, including leisure, travel, and airlines, as well as traditional value sectors including energy, materials, and financials. With inflation as a backdrop, we believe that the value companies we focus on will have both secular and cyclical tailwinds to support return potential.
1 Source: Federal Reserve Bank of St. Louis, www.officialdata.org, Neuberger Berman analysis. Data through January 2022.
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