Observations: Value Vs. Growth, Does Another Fed Hike Matter?

Observations: Value Vs. Growth, Does Another Fed Hike Matter?

Adam Sparkman:        So, Ben, maybe sticking with the top of valuation differences, within value and income-oriented stocks, you know obviously they, they typically trade at a discount to their growth counterparts but really since the pandemic, we’ve now seen that, that valuation spread really blow out to, almost 50 percent today. If you look back, historically, to 2006, the dispersion in, in valuation has typically been, kind of, 25 to 30 percent. So given this widening, what’s your outlook for value in income stocks, moving forward?

Ben Kirby:      It’s a great question.  I agree with all those assessments, and I think it, it sets a great starting place for, we think, a multiyear period of value, um, outperformance. So, think about the last decade, as Jeff alluded to, interest rates were near zero. Money was, was very available. We think the next 10 years will look a lot different. There’s a real cost of capital today. Inflation’s gonna run at a somewhat higher rate, we think, in the next 10 years and in, in the last 10 years, and those are a couple catalysts, for, value stocks to perform a little bit better. This year, the MSCI World High Dividend Yield Index has only returned 3 percent. So, whenever people think about a pretty good equity market in 2023, there’s actually a part of the market that really has not kept up, and it’s these higher-dividend-paying companies. What I would add to that is from this starting place and valuation, forward returns on, market-cap-weighted indexes, is not likely to be very great over the next 10-year period. Again, valuation is not a great predictor of your next year’s return, but it’s a very good predictor of 10-year-compound return. On that basis, we think that the next 10 years, stocks will probably return less per year than they have in the past, starting with a higher-dividend yield, if that’s a strategy to pursue, we think is a great way to outperform the indexes over that time period. If stocks are gonna return 5 to 6 percent, per year, over the next 10 years, and you can start with companies paying a dividend of 3 to 5 percent, that’s gonna be a great head start, to outperform overtime.

Adam Sparkman:        Jeff, maybe turning to fixed-income markets.  the fed, last month, cape, kept its target rate unchanged, as, as expected, but they still find themselves in a bit of a balancing act. On the one hand, signs of recession are still definitely flashing red but on the other hand, inflation has come down dramatically, from last year’s high. From here, do you see the fed raising rates one more time, or do you think they might keep things, kind of, steady from here unless we really see signs of a recession:

Jeff Klingelhofer:        Yeah. I’ll put myself on the record. I think that we get one more fed-rate hike, but I’ll also put myself on the record in saying, it doesn’t matter. I think what we need to do is listen to the Federal Reserve. They’ve been asked this question many times. We talk about the fed as having a dual mandate, maximum employment on one side, per your thoughts, yes, we’re starting to see some potential weakness, not directly in the employment market but leading indicators to the employment market, the growth side of the equation.

But they’re clearly missing on the inflation side, and they’ve told us, exceptionally clearly, they will focus on getting inflation back towards trend, at the cost of growth. All right. As they look out, as Ben has alluded to over the long period of time, we have to have price stability before you can get growth stability and maximum employment, so long as we see inflation not returning to the 2 percent fed target, I think that they’ll be continued to, to push towards additional, additional hikes. Now it’s a balance that, we’ve talked a little bit about, right? We continue to see a recession coming, and I think the fed does, too. So, at some point, they’re happy to pause for a very prolonged period of time. But the last piece that I just want to continue to talk about and reassert is, I think the fed is willing to tolerate above-trend inflation, but it’s the composition of that inflation that really matters. Predominantly where we’ve seen that stall, is in the cost of labor and most of that is coming from low-wage income earners. The feds more willing to, to tolerate that continued push and elevated inflation if it comes from compressing the wage gap. So they don’t have to get back, directly, to 2 percent, which is their long-term objective but even at today’s levels of close to 4 percent, I think it’s still too high for the fed, and I do continue to expect at least one more hike from them.

Adam Sparkman:        Okay. Jeff, last time we discussed that really that’s core fixed income is an exercise in balance-sheet investing.  when investing, I know that you and your team consider, really the three central, central balance sheets, government, corporate and consumer. In a variety of ways, each is showing some signs of decay. Given this precarious environment, where are you seeing the best relative-value opportunities across the fixed-income landscape?

Jeff Klingelhofer:        Yeah, I think for a long while we had really liked the consumer balance sheet, but in today’s environment, we are seeing that deteriorate, perhaps the most rapidly.

It’s a little bit of a tug-of-war between whether the consumer’s deteriorating at a faster pace or, or, or the government balance sheet’s deteriorating in a faster pace, but we continue to believe that the government balance sheets, amongst, certainly amongst the, the developed economies, aren’t really a challenge. At this point in the cycle, what we want to do is focus on forward-looking metrics. We’ve talked about the, the boon of low-interest rates. We think that’s come to an end. It allowed consumers to significantly expand their balance sheet coming out of the GFC and allowed them to pull a lot of demand forward, but it’s been alluded to, now they’re feeling the pain of higher mortgage rates, higher financing costs across the board. Corporations are a little bit more of a balancing act, in the sense that the very highest quality companies have actually seen an improvement in their balance sheets because they’ve got a lot of cash.

So, they’ve termed out their debt at very low levels, and the cash today is yielding 5-and-a-half, or even potentially 6 percent but all of that, too, will catch up, as they have to refinance. So, I’d say mostly what we’re focused on is a move from lower quality, either companies or consumers, into the higher-quality space amongst both of those, more acyclically-oriented as well as what we want to do within the portfolios, is we want to move that form of credit volatility under the shorter-duration spectrum, and we want to focus on some of the longer interest-rate volatility, things like U.S. Treasuries and agency mortgages as a ballast to some of that short-credit volatility.

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