The era of easy money is near and value investing may be due for a return. The Federal Reserve on Wednesday announced its plan to cool inflation in the red, reducing monthly bond purchases from March and raising short-term interest rates up to three times next year. The central bank has kept interest rates close to zero since March 2020 to stimulate the economy amid the COVID-19 pandemic, and has been buying billions of bonds each month to ensure money continues to circulate. economy
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Wednesday’s announcement signals a significant change in monetary policy that will reverberate throughout the stock market. The rise in interest rates in 2022 does not mean that investors should expect an imminent market collapse, but should lead to a renewed emphasis on company fundamentals and value investing, according to Luke Templeman of Deutsche Bank.
“The end of the stimulus is certain to slow the flow of money into the stock markets. And if rising interest rates push bond yields higher, investors will have options elsewhere in the bond markets and other tax-sensitive investments that have been ignored in recent years,” Templeman wrote in the the main themes of the company for 2022. “As investments outside of equities become more attractive, frustrated active asset managers may finally witness the return of fundamental investments.”
What is value investing?
Value investing is a strategy based on finding undervalued companies that are trading at a lower price than their underlying fundamentals would suggest. Using fundamental analysis, Value investors consider the assets, liabilities, cash flow and other factors of companies to assess their intrinsic value. Value investors look for stocks that are considered undervalued by the market.
This strategy is often contracted growth investment, which looks for stocks with the potential to outperform the broader market. While Warren Buffet is considered the world’s preeminent value investor, growth investing has largely outperformed its counterpart over the past decade. In fact, the S&P 500 Value index has lagged the S&P 500 Growth index by nearly seven percentage points over the past 10 years.
So why does Deutsche Bank see value potentially recovering in 2022? The answer may be in the increase of interest rates.
Loose fiscal policies set for tight
Value stocks have not only been outperformed by growth stocks over the past decade, but by the market as a whole. While the S&P 500 Value index has a 10-year annualized return of 10.56%, the S&P 500 as a whole has produced an annualized return of 14.35% over the same time.
Templeman points to the low interest rate environment as a primary reason for this disparity.
“The reason for the underperformance of ‘value’ is not only explained by the outperformance of technology ‘growth’ stocks. It is also because the financial crisis catalyzed the era of super-good money,” he wrote Templeman. “A significant part of this is poured into the stock markets, many through passive funds that bought the index. As a result, all the shares began to move in a similar way, regardless of the profitability of the underlying companies.”
U target federal funds ratesa range for short-term interest rates set by the Federal Reserve, has spent much of the past 12 years near zero.
In December 2008, the Federal Reserve lowered interest rates to near zero and kept them there throughout the recovery from the global financial crisis. It wasn’t until December 2015 when the Federal Open Market Committee raised the target federal funds rate above 0% to .25% for the first time since December 2008. During this time, the Federal Reserve also expanded his purchase of longer. term securities in an effort to lower long-term interest rates and increase economic activity.
While the target rate increased steadily in the following years and reached 2.25-2.50% at the end of 2018, the low-interest environment returned at the beginning of the COVID-19 pandemic. The Federal Reserve cut rates twice in March 2020 in response to the economic turmoil the pandemic has unleashed, leaving the target federal funds rate between 0% and .25%. It has remained close to zero since then.
But interest rates are poised to rise once again as federal officials look for ways to fight back historically high inflation. Consumer prices were 6.8% higher in November than a year earlier, the largest 12-month difference since June 1982. On Wednesday, the Federal Reserve projected that it could raise rates three times in 2022, followed by two rate increases each. in 2023 and 2024. The central bank also announced that it will reduce its monthly bond purchases twice as fast as it originally planned.
What does all this mean for investors? They may want to adopt a value-based approach, Templeman wrote.
“In 2022, as stock markets lose the flood of money that has supported all stocks over the past decade, investors may be forced to become more demanding,” he wrote. “None of this means that equity markets in general will crash. Rather, it may lead to a reordering in equity markets as we witness the return of fundamental value investing.”
Bottom line
For years, the stock market has benefited from “easy” monetary policy adopted by the Federal Reserve after the global financial crisis, wrote Luke Templeman of Deutsche Bank. But with both interest rates expected to rise and government stimulus set to taper in 2022, Templeman said fundamental value investors could see a resurgence.
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