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US 10-year Treasury yields closed last Thursday at 1.70%, close to the late-March highs and almost 40 bps above last month’s level. European yields, especially in Germany, followed a similar pattern. This renewed upward trend in yields, beginning in August 2021, gathered pace after the Federal Reserve meeting of 22 September, which closed with the Fed adopting a less-than-accommodative stance. Given what had happened at the beginning of the year, we might have expected a fresh rally in value stocks versus growth stocks. That has not happened, or in any event only to a very limited extent. Admittedly, for a week after the Fed meeting, value stocks strongly outperformed in a somewhat bearish market. But that trend quickly ran out of steam. Since the beginning of October, in both the United States and Europe, value and growth indices have performed similarly, despite the rise in yields. This situation which, on the face of it, may seem surprising, is the result of several factors.
First of all, there is the macroeconomic momentum. Although we reject the term “stagflation” which, in our view, is hardly relevant, the fact remains that a stronger and earlier slowdown in activity has triggered concerns. Energy shortages, inflation that could eventually affect demand, Chinese real estate risk and production chain and supply distortions are all among the factors dampening investor enthusiasm. This has the effect of encouraging them to favour visible growth stocks and to shun more cyclical value stocks. Therefore, while some value sectors, such as banking and energy, are at the top of the league in terms of performance, boosted by rising interest rates and surging commodity prices, others, such as tourism and capital goods, are at the bottom of the league, because of these uncertainties about the sustainability of the economic cycle.
Next, after weeks dominated by macroeconomic factors, in particular inflation, microeconomic factors have regained sway on markets, at a time when the corporate earnings season is in full swing in the United States and is starting in Europe. So far, the numbers reported have been strong, with more than 80% of US companies beating earnings expectations. This is contributing to an upward revision of earnings outlooks, which, in an equity market that has been marking time since the start of the summer, automatically leads to a reduction in valuations – thereby enhancing the attractiveness of growth stocks, which had become very expensive.
Lastly, there are the inflows, in particular those from US retail investors. Having been less active in September, they have now returned to the markets, systematically buying on dips, as they have frequently done since the beginning of the year. Moreover, most of this money is flowing either into the major indices, which are more neutral in terms of style (possibly even more exposed to growth stocks), or into very specific investment themes, linked in particular to the technology sector. Here again these inflows favour the “growth” style in a context which, on the face of it, would seem to be more favourable to value stocks.
These factors could persist for several more weeks, in the absence of any major changes on the macro front, in particular as regards the economic outlook. Therefore, while some sectors may attract interest (for example banks, which will benefit from the rise in interest rates), in our view it is advisable at the current time to maintain a balanced allocation in terms of style, and to adopt a selective approach within sectors.
Written on 22 October 2021 by Olivier de Berranger, CIO and Enguerrand Artaz, Fund Manager