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Stocks to Buy: Growth vs Value: Which Stocks Do Better in a High Inflation Environment?

Sky-high inflation is pinching the pockets of major economies. Inflation figures released this week in the UK, US and India are consistently higher. Although measures have been taken to reduce inflation, uncertainty persists. It seems likely that inflation will remain above central banks’ comfort levels for some time. Investors often face this dilemma when investing during such high inflation.

I believe value stocks will beat growth stocks. Before delving into them, find out their motivations.

The combination of the three factors together results in superior or underperforming performance.

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Growth stocks, especially with high valuation multiples, are susceptible to high rates of inflation. To curb inflation, the central bank raises interest rates, which ultimately causes bond yields to rise. This is not good for growth stocks.

Their expected income depends on the distant future and is discounted to net present value with the use of a discount rate (bond yield).

Rising interest rates imply a higher discount rate for growth stocks, which reduces the net present value of future cash flows. Therefore, the multiple tends to decrease as the discount rate increases.

Thus, during a rate hike, the P/E multiple is negatively bound to an increase in bond yields.

Value stocks work in reverse as bond yields move north. Value stocks become attractive during such times because they trade much closer to or in fact even below their intrinsic value. Value stocks also have a strong cash flow, which makes them more attractive during such times unlike growth stocks.

Throughout history, we have observed that periods of inflation are positively correlated with the performance of value stocks.

The ratio between the Russell Growth Index and the Russell Value Index shows the better performance of growth stocks as US 10-year bond yields are on a downward trajectory. However, it bottomed out in July 2020. On the other hand, when yields started to rise, value stocks started to outperform.

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From where we are now, the fear of higher US inflation is still present.

Given the US Fed’s hawkish stance, some are expecting an even 100 bps rate hike. As 10-year bond yields continue to rise, value stocks are making a comeback. Due to their quick and sharp trend reversals, early signs were already visible.

The Russell Growth Index is down ~25% while the Russell Value Index is down just 12% year-to-date.

In the midst of turbulent times of inflation, one should remember Albert Einstein’s quote, “Amidst difficulties lies opportunity”.

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Expectations for the week

Early next week, the FOMC and press conference will be the main headlines. Inflation in the US created havoc in the indexes as CPI and core inflation for August 2022 both came in above street expectations. Markets globally are expected to dance to the tune of the Fed meeting results. Although India has performed relatively better than all major markets, it is expected to remain volatile. Nifty50 closed the week at 17,530.85.

(Disclaimer: The recommendations, suggestions, views and opinions expressed by experts are their own. They do not represent the views of The Economic Times)

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