Market Musings 02/10/21: Time to buy Cyclical Value
Recent podcasts you may care to listen to:
Line up cyclical value for the rest of the year
There are two powerful reasons for looking hard at cyclical value stocks for the rest of the year, now that we have entered Q4.
These two reasons are:
- Rising inflation expectations, and
- Winter seasonality
Put simply, value stocks tend to outperform when inflation expectations are rising, as these rising expectations usually reflect higher nominal growth in the economy, which tends to boost the growth and profitability of more cyclical sectors and stocks.
Inflation is set to remain higher for longer
Guess what? With the surge in inflation rates driven by a whole host of factors, including supply chain disruptions, surging food and energy prices and rising wages as employment recovers, inflation expectations are unsurprisingly on their way higher.
Value beats Growth in the US when US inflation expectations rise
Source: BNP Paribas, Bloomberg
In the US, for example, growth has beaten value by a distance over the last few years since 2014, as long-term inflation expectations fell from around 3% to as low as 1.5% in mid-2020.
But today, with US CPI inflation rates running at over 5%, inflation expectations are increasing, currently at 2.2%. The more that these expectations rise, the greater the chance that US value stocks will outperform growth at last, as happened in the early 2000s.
Bear in mind that an outsized proportion of the US CPI inflation basket is the “cost of shelter”, i.e. the cost of housing. This component is largely driven by house prices, which of course have been surging of late. The chart below demonstrates that the CPI rent component lags actual house price growth by about 18 months. This suggests that US inflation is set to remain high for some time to come, given this delayed reaction to house prices.
US rent component of CPI lags actual house price growth by c.18 months
Source: Federal Bank of Dallas
Of course, the US is not the only country with surging inflation. To a lesser extent, inflation is rising in the UK and the rest of Europe on the back of similar factors. The…
