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Peter Hardy, senior client portfolio manager for Global Value Equities, American Century Investments.
As we have discussed in the past, easy money and low interest rates benefit long duration assets versus short duration ones. Everybody understands it from a fixed income perspective: when interest rates fall, 30-year bonds do better than one-year bonds. And when interest rates rise, the opposite occurs. It’s less well understood in equities, but it’s exhibiting itself here thus far in January 2022. Growth stocks tend to be longer duration versus value stocks. Tesla is more like a 30-year bond, maybe even more like a 100-year one, while GM is more like a five year bond. So just from an asset valuation perspective, value should benefit versus growth in a rising rate environment.
Additionally, the valuation disparity between growth and value styles are at historically wide levels. You’re paying more for growth stocks versus value stocks than you historically typically do. This makes the interest rate sensitivity of growth stocks even higher than the typical environment. We’re a value manager, so I’m speaking to our book a little bit, but I would anticipate this being an environment where value outperforms. And we’ve seen this thus far here, year-to-date, in January 2022. Plus, growth has outperformed for over a decade, so value is due.
Inflation has explicit earnings benefits to value stocks, also. Sectors like financials, energy and materials see their earnings go up in rising rate or inflationary periods. And these sectors are value sectors. While we have meaningful exposure to those areas, our biggest over-weights are in consumer staples and utilities. We also have large individual weights in select healthcare names. These three areas have all had flat returns over the last year and we believe the market’s disregard for them has created compelling valuation opportunities. These names have historically sustainable yields, high returns on capital, low debt levels and are seasoned businesses.
Additionally, the market has tended to selectively have inflationary concerns about these names, while not attributing the same cost or valuation pressures to other areas in market. Our largest under-weights, or areas we’re avoiding, are in consumer discretionary, communication services and real estate, where the stocks don’t have a justifiable valuation, or they’re a large number of names that don’t meet our investible criterion, quality criterion either because of lack of cashflow generation, too high debt levels or both.
One of the largest over-weights in the portfolio is Medtronic, a medical device company. Medtronic has seen its stock suffer due to Covid impact on elective procedures. Elective procedures have been canceled, and by virtue of that, Medtronic short-term earnings have been muted. What we see, over time, is that elective procedure cancellations come back, and the selloff in Medtronic stock is creating a compelling valuation opportunity. Additionally, it is one of the highest quality names in our universe of securities with very high returns on capital, a manageable debt level, and healthy and sustainable yield.