Inflation Could Mean Value Stocks’ Time to Shine
Bitcoin, gold and oil are all having a moment, but the best haven might be value stocks.
Bitcoin, gold and oil are all having a moment, but the best haven might be value stocks.
Bitcoin, gold, oil, real estate—many assets are finding themselves on investors’ radar screens as concerns about inflation grow. The best refuge might be one that has been out of fashion for a while, though: boring old value stocks.
Value investing had a brief moment of superior performance early this year, only to sink back into second-class status as stocks like Tesla with triple-digit earnings multiples—and many with no earnings at all—surged anew. A broad basket of cheap stocks represented by the Russell 3000 Value Index has appreciated by a respectable 80% in the past five years. Russell’s corresponding basket of growth stocks has done more than 100 percentage points better, however.
Many people think of stocks of any stripe as a lousy investment when the cost of living surges, because the last time U.S. inflation was a major problem—from the late 1960s through the early 1980s—they went exactly nowhere and lost money in real terms. But companies with real assets, debts that are eroded by inflation and the ability to raise prices can do well and have done so at other times when inflation was elevated.
Even when they didn’t, value stocks were good relative performers. Decades like the 1940s, 1970s and 1980s saw value stocks beat growth amid fairly high inflation. By contrast, decades with low inflation or deflation such as the 2010s, 1930s and 1990s saw the opposite trend, according to data from researchers Eugene Fama and Kenneth French.
“It does feel like there is a shift,” says John Alberg, co-founder of Euclidean Technologies, which uses machine learning to manage long-term investments based on historical trends.
If inflation really is “transitory”—the result of supply-chain pressures that will soon reverse—then maybe growth can continue to trounce value for a while. But concerns about inflation have a way of becoming entrenched and turning into a persistent trend as companies succeed in pushing through price increases and workers demand higher pay. A search for “inflation” on media research site Factiva shows more hits in October, which isn’t yet over, than during any month in the past decade.
Companies that make electric cars, experimental drugs or software can raise prices, too, but their shares might be less desirable if inflation really picks up. The simple reason, Mr. Alberg surmises, is that when interest rates rise—as they tend to do during inflationary periods—the prospect of a payoff in the future is worth less than a more certain stream of cash in the near term.
Asset manager GMO recently opined on inflation hedges and found flaws with all of those now in fashion. Buying insurance backed by the full faith and credit of the U.S. Treasury through TIPS—bonds indexed to inflation—has become expensive.
So are industrial commodities, which cost money to store or to hold via financial instruments like futures. Traditional and newer havens like gold or bitcoin, meanwhile, have no intrinsic worth so they might or might not protect you. The best strategy, according to GMO, is to bet on a store of value in the form of cheap stocks.
“This is like being offered inflation insurance at a discount,” the asset manager said.
Note that this could merely mean a less-bad performance. Some decades when value stocks provided a haven and inflation was on the higher side, such as the 1980s, had stellar returns, but they started from a point when all stocks were a bargain. The cyclically adjusted price-to-earnings ratio maintained by Yale professor Robert Shiller was in the single digits in 1981. Today it is around 39 times—its highest level since shortly after the technology stock bubble burst 21 years ago and above the 1929 peak.
Value stocks might not be the most exciting inflation hedge, but havens rarely are.
Reprinted by permission of The Wall Street Journal, Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: October 26, 2021.
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Food prices continue to rise at a rapid pace, surprising central banks and pressuring debt-laden governments
LONDON—Fresh out of an energy crisis, Europeans are facing a food-price explosion that is changing diets and forcing consumers across the region to tighten their belts—literally.
This is happening even though inflation as a whole is falling thanks to lower energy prices, presenting a new policy challenge for governments that deployed billions in aid last year to keep businesses and households afloat through the worst energy crisis in decades.
New data on Wednesday showed inflation in the U.K. fell sharply in April as energy prices cooled, following a similar pattern around Europe and in the U.S. But food prices were 19.3% higher than a year earlier.
The continued surge in food prices has caught central bankers off guard and pressured governments that are still reeling from the cost of last year’s emergency support to come to the rescue. And it is pressuring household budgets that are also under strain from rising borrowing costs.
In France, households have cut their food purchases by more than 10% since the invasion of Ukraine, while their purchases of energy have fallen by 4.8%.
In Germany, sales of food fell 1.1% in March from the previous month, and were down 10.3% from a year earlier, the largest drop since records began in 1994. According to the Federal Information Centre for Agriculture, meat consumption was lower in 2022 than at any time since records began in 1989, although it said that might partly reflect a continuing shift toward more plant-based diets.
Food retailers’ profit margins have contracted because they can’t pass on the entire price increases from their suppliers to their customers. Markus Mosa, chief executive of the Edeka supermarket chain, told German media that the company had stopped ordering products from several large suppliers because of rocketing prices.
A survey by the U.K.’s statistics agency earlier this month found that almost three-fifths of the poorest 20% of households were cutting back on food purchases.
“This is an access problem,” said Ludovic Subran, chief economist at insurer Allianz, who previously worked at the United Nations World Food Program. “Total food production has not plummeted. This is an entitlement crisis.”
Food accounts for a much larger share of consumer spending than energy, so a smaller rise in prices has a greater impact on budgets. The U.K.’s Resolution Foundation estimates that by the summer, the cumulative rise in food bills since 2020 will have amounted to 28 billion pounds, equivalent to $34.76 billion, outstripping the rise in energy bills, estimated at £25 billion.
“The cost of living crisis isn’t ending, it is just entering a new phase,” Torsten Bell, the research group’s chief executive, wrote in a recent report.
Food isn’t the only driver of inflation. In the U.K., the core rate of inflation—which excludes food and energy—rose to 6.8% in April from 6.2% in March, its highest level since 1992. Core inflation was close to its record high in the eurozone during the same month.
Still, Bank of England Gov. Andrew Bailey told lawmakers Tuesday that food prices now constitute a “fourth shock” to inflation after the bottlenecks that jammed supply chains during the Covid-19 pandemic, the rise in energy prices that accompanied Russia’s invasion of Ukraine, and surprisingly tight labor markets.
Europe’s governments spent heavily on supporting households as energy prices soared. Now they have less room to borrow given the surge in debt since the pandemic struck in 2020.
Some governments—including those of Italy, Spain and Portugal—have cut sales taxes on food products to ease the burden on consumers. Others are leaning on food retailers to keep their prices in check. In March, the French government negotiated an agreement with leading retailers to refrain from price rises if it is possible to do so.
Retailers have also come under scrutiny in Ireland and a number of other European countries. In the U.K., lawmakers have launched an investigation into the entire food supply chain “from farm to fork.”
“Yesterday I had the food producers into Downing Street, and we’ve also been talking to the supermarkets, to the farmers, looking at every element of the supply chain and what we can do to pass on some of the reduction in costs that are coming through to consumers as fast as possible,” U.K. Treasury Chief Jeremy Hunt said during The Wall Street Journal’s CEO Council Summit in London.
The government’s Competition and Markets Authority last week said it would take a closer look at retailers.
“Given ongoing concerns about high prices, we are stepping up our work in the grocery sector to help ensure competition is working well,” said Sarah Cardell, who heads the CMA.
Some economists expect that added scrutiny to yield concrete results, assuming retailers won’t want to tarnish their image and will lean on their suppliers to keep prices down.
“With supermarkets now more heavily under the political spotlight, we think it more likely that price momentum in the food basket slows,” said Sanjay Raja, an economist at Deutsche Bank.
It isn’t entirely clear why food prices have risen so fast for so long. In world commodity markets, which set the prices received by farmers, food prices have been falling since April 2022. But raw commodity costs are just one part of the final price. Consumers are also paying for processing, packaging, transport and distribution, and the size of the gap between the farm and the dining table is unusually wide.
The BOE’s Bailey thinks one reason for the bank having misjudged food prices is that food producers entered into longer-term but relatively expensive contracts with fertilizer, energy and other suppliers around the time of Russia’s invasion of Ukraine in their eagerness to guarantee availability at a time of uncertainty.
But as the pressures being placed on retailers suggest, some policy makers suspect that an increase in profit margins may also have played a role. Speaking to lawmakers, Bailey was wary of placing any blame on food suppliers.
“It’s a story about rebuilding margins that were squeezed in the early part of last year,” he said.
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