Over the past two months, large investors have bought stocks of companies with strong growth prospects over cheaper value stocks in a sharp reversal prompted by a shift in sentiment on interest rates, l inflation and the threat of a recession in the United States.

U.S. value strategies, which seek out discount companies based on metrics such as earnings, cash flow or book value, have lagged since mid-June, when the index The blue-chip S&P 500 has begun to rebound from its low point this year, a rally fueled by new investor bets on tech stocks and other growth-sensitive sectors.

This renewed interest in growth stocks and the underperformance of value represents a return to a trend that was dominant from the early days of the coronavirus crisis in 2020 until December 2021. The surge in inflation and central bank plans to scrap pandemic-era stimulus took over growth stocks in the first half of 2022, but now recession jitters have swung the pendulum back.

“Investors were obsessed with inflation risks in the first half of the year and they are now obsessed with recession fears. This explains the violent shift in sentiment towards growth stocks relative to value,” said Michael Hartnett, chief investment strategist at Bank of America.

The S&P 500 Value Index gained 12.6%, including dividends, from June 16 to the close of games Thursday, while the S&P 500 Growth Index generated a total return of 22%, reflecting changes portfolio of some of the world’s largest investors.

For the first time since August 2020, more fund managers now expect growth stocks to outperform value over the next 12 months, according to the latest BofA survey, which surveyed the views of 250 investment managers with combined assets of $752 billion.

About 88% of investors polled by the bank expect US inflation to decline over the next 12 months and their fears that the Fed will impose further drastic interest rate hikes have also started to fade.

That led to a rotation from defensive sectors, including utilities, healthcare and consumer staples, into technology stocks, banks, energy and consumer discretionary in July, Hartnett said.

Tech titans Apple, Amazon and Tesla benefited from the rebound in growth stocks while value players including Pfizer and Dow struggled to keep pace.

The reversal in sentiment is also evident in exchange-traded fund flows in the United States. State Street data shows U.S.-listed value ETFs saw net outflows of $39 million in July, the first drawdowns after 11 months of positive inflows. Meanwhile, U.S.-listed growth-oriented ETFs, which were unpopular in the first four months of this year, attracted net inflows of $4.9 billion in July.

Toby Gibb, global chief investment officer for equities and fixed income at Fidelity International, said as concerns shifted from the risk of stagflation to recession, investors showed more willingness to pay for companies. that can generate strong revenue growth.

“But it’s still an attractive environment for value strategies based on idiosyncratic or contrary ideas, especially if a company’s fundamentals are strong. Buying cheap stocks just because they are trading at a cheap valuation is not likely to succeed as a strategy. Investors need to be more discerning when looking for companies that can be considered value,” Gibb said.

According to quantitative investment manager AQR, the valuation gap between cheap and expensive stocks globally – known as the value gap – has returned to the extreme levels seen at the height of the US technology stock price bubble of March 2000.

Chart showing the extreme gap in valuations between expensive and cheap stocks globally (value gap, z-score)

Richard Halle, portfolio manager at M&G Investments, said the odds of success have swung more in favor of value strategies because the dispersion of valuations between cheap and expensive stocks is so extreme.

Additionally, the severe impact of the current energy price shock has created greater uncertainty about the outlook for corporate earnings.

“The high valuations attached to growth stocks imply a high degree of certainty about future earnings. However, the outlook for the economy has deteriorated and there will be losers as some businesses struggle to match their rising input costs with the prices they charge customers,” said Halle, who suggests investing in companies with lower price/earnings ratios. rather than more expensive growth stocks.

But the continued deterioration in economic activity data means it’s too early to return to value stocks, according to Mislav Matejka, equity strategist at JPMorgan.

“Stronger economic data is generally supportive for value sectors, including financials. We don’t see the macro data strengthening until the fourth quarter,” Matejka said.

Growing fears that the US economy is entering a recession have increased demand for safe government bonds. As a result, 10-year US Treasury bond yields fell to 3% from a high of nearly 3.5% on June 14, the day before the Federal Reserve hiked its key rate by 0.75 points. percentage.

Roger Aliaga-Díaz, chief economist for the Americas at Vanguard, the world’s second-largest asset manager, said value strategies are generally more exposed to economically sensitive cyclical stocks, so they tend to fall out of favor when investors anticipate a recession.

However, he also warned that investors should not expect any loosening of monetary policy in the near future given the severity of current inflationary pressures and the need for the Fed and other central banks to restore stability to markets. price.

Warning signs of a recession in the US bond market are being ignored, according to Michael Wilson, chief investment officer at Morgan Stanley.

“Investors interpreted lower bond yields as positive for growth stocks. They also assume that earnings from growth stocks will be more resilient during a recession. But that’s a mistake,” Wilson said.