Will value stocks beat growth stocks?

Despite value stocks' significant underperformance against growth over the past 25 years, analysis suggests they are poised for outperformance if inflation worsens. A statistically significant correlation exists between the value premium and inflation, with an econometric model indicating that a 1 percentage point increase in inflation could boost the value premium by 3 percentage points. This implies that investors anticipating higher inflation, perhaps due to factors like trade wars, should strategically favor value over growth equities.

Analysis

Despite a significant and prolonged period of underperformance, where value stocks have lagged growth stocks by 5.5 annualized percentage points over the last decade and 10.2 percentage points in the last 12 months, a specific macroeconomic condition could trigger a reversal. A statistically significant correlation, at the 95% confidence level, has been identified between the value premium and inflation. Analysis based on an econometric model from the last decade's data suggests that for every 1 percentage point increase in inflation, the value premium—the spread between value and growth stock returns—expands by 3 percentage points. This relationship provides a clear framework for investors: an outlook for accelerating inflation, potentially driven by factors such as a trade war, would support a tactical overweight to value stocks. Value is defined here by traditional metrics including high dividend yields and low price-to-book, price-to-sales, and price-to-forward-earnings ratios.

Key Decisions for Investors

• Investors with a high-conviction view that inflation will materially increase should consider a tactical rotation from growth-oriented equities into value stocks.
• Given value's substantial long-term underperformance, this strategy is highly dependent on the inflation thesis playing out; a failure for inflation to accelerate would likely result in continued underperformance relative to growth.
• Monitor key inflation indicators, such as the Consumer Price Index (CPI), as the primary signal for timing an allocation shift towards value-oriented equities.
• When selecting securities for a value-focused portfolio, prioritize companies exhibiting the specific characteristics cited, such as high dividend yields and low valuation multiples across price-to-book, price-to-sales, and price-to-forward-earnings.