Buy the dip, wrote J.P. Morgan’s strategists early this past week. As calls to courage go, it wasn’t exactly Churchill during the Blitz.
The dip in this case was a 2% decline, year to date, in the S&P 500, bringing its 10-year gain to 261%, not counting dividends. Also, many of the biggest individual dippers this year have been thinly profitable highfliers, like cloud player Snowflake (ticker: SNOW), or assets that are backed by suspended disbelief, like crypto.
But these are quibbles. I take J.P. Morgan’s broader point, which is that an expected rise in interest rates needn’t derail stocks. Yes, the U.S. inflation rate just hit 7%, the highest since 1982, back when E.T. was phoning home and the rich kid on my street got a Commodore 64 computer—his old man worked for IBM. And yes, there’s growing agreement that some of that added inflation will stick, and action is needed.
“The problem is, as that inflationary mind-set gets embedded in prices and wages, the Fed has to respond with kind of hitting the economy over the head with a brick,” says Edmund Bellord, a portfolio manager at Harding Loevner.
But the starting point for rates is so sharply negative after adjusting for inflation, he says, that raising rates might not be so bad for stocks.
J.P. Morgan compares now with late 2018, when rate increases sparked a stock selloff, and the Fed later reversed course. Back then, the starting point for real rates was positive, and the economy was weakening.
This year, the bank predicts, will be characterized by the end of the pandemic and a full global recovery. That hinges on its expectation that “Omicron’s lower severity and high transmissibility crowds out more severe variants and leads to broad natural immunity.” I, for one, can’t wait to get back out there this year and decline to travel because of runaway pricing, rather than fear of infection.
Rather than buy the bob, or waffle, or whatever the market term is for a not-quite dip, consider buying something that’s rising: value stocks. The Invesco S&P 500 Pure Value exchange-traded fund (RPV) is up 7% this year. It tracks a basket of big U.S. companies that look cheap, relative to earnings, sales, and the book value of assets. Invesco S&P 500 Pure Growth (RPG), which holds companies with strong earnings growth and price momentum, is down 7%.
Low interest rates flatter the valuation math on growth stocks; when bond yields are minuscule, investors might as well park money in promising companies whose cash flows won’t ramp up for years. Growth has beaten value by around 100 percentage points over the past decade, using the aforementioned ETFs.
During the pandemic, the performance difference has widened, because the Federal Reserve has used bond purchases to push yields even lower, and spending has shifted in favor of growthy online services.
Solita Marcelli, chief investment officer for the Americas at UBS Global Wealth Management, says that price-to-earnings ratios for growth stocks have ballooned to 31 from 22 during the pandemic, while those for value stocks have risen more modestly, to 16 from 13. The difference between the two current numbers—15—compares with a historical average of six.
Ironically, value stocks are likely to produce faster earnings growth than growth stocks this year, according to Credit Suisse. That’s because companies that were hit hard by the pandemic stand to bounce back as it abates.
There have been many false starts for a shift into value stocks over the past decade. This could be one of them if the economy fizzles, inflation cools, and near-zero interest rates hold. Either way, a wholesale shift into value stocks seems imprudent.
“There is still this huge digitization effort across corporate America,” Marcelli says. “Are we saying value is going to outperform growth for the next five years? Not necessarily.”
But looking at returns over the past decade, the S&P 500 index has performed more like that growth ETF than the value one. That’s because the index and growth ETF have at times been dominated by the same world-beating tech giants. That has worked well, but it has also left passive investors all-in on growth.
A simple adjustment is to buy a value ETF. A less-simple one is to shop for individual stocks among value-priced names that have been running ahead of the market this year. A quick scan of the S&P 500 shows healthy gains for Cummins (CMI), Royal Caribbean Group (RCL), Deere (DE), Chevron (CVX), Citizens Financial Group (CFG), Ford Motor (F), and ViacomCBS (VIAB).
I’m concerned about the United Kingdom. Michel Doukeris, the new CEO of Anheuser-Busch InBev (BUD), the world’s biggest brewer, tells me he has been selling so many home beer taps there that they now outnumber pubs. How will anyone leave the house? If you haven’t heard from friends there in a while, check in, or at least send pretzels.
Doukeris’ order is a tall one. AB InBev has been rolling up the beer industry, but its stock returns have stunk over the past decade. Demand has shifted, especially during the pandemic, toward spirits and fizzy, fruity stuff in cans, like hard seltzers and ready-to-drink cocktails.
AB InBev has those, too, but it’s awash in beer. Doukeris says it’s time for growth and deleveraging.
Growth will come from new products worldwide, like one called Brutal Fruit in South Africa and Cutwater Spirits in the U.S., and new services, such as delivery of cold beer in 30 minutes or less in some markets. Good news, Florida: Doukeris says he’s testing home beer taps in Miami.
He also plans to make fuller use of AB InBev’s scale. Some ideas seem more immediately deliverable than others. Selling more marketing, distribution, financial, and tech services to small players? Makes sense. Turning spent grains into protein for me to dig into at dinner? Not even if you throw in a sixer of Brutal Fruit.