First off, let’s just say that all the volatility in stock markets is about rising interest rate fears from the Federal Reserve (Fed). The ongoing turmoil is about late cycle fears of rising rates and yields.
Those fears are rooted in real problems with inflation globally, particularly in the US. And it is well worth listening to what the markets are saying.
To summarise the conclusion upfront, investors who have been in growth and tech stocks should seriously consider switching to value stocks. This is what I have previously called “late cycle rotations”.
Now, of course, if you are a truly long-term investor with a 10-year time horizon, it may still make perfect sense to hold on to value-creating tech giants.
But if your horizon is the next 12 months, you may want to consider what rising interest rates could do to your stocks.
Why rising rates damage tech more than value stocks
Higher yields will likely hurt “growth” stocks more than “value” stocks, given the perception that tech stocks have longer earnings duration than value stocks.
In essence, they have a larger part of their earnings in the more distant future and, hence, their valuations are more vulnerable to rising rates.
Whatever the merits of that perception, I simply note that over the past year, the Nasdaq-100 Index has had a vastly higher beta to 7-10 year US Treasuries.
And this is playing out again in the heavy selling of tech as Fed rate hikes approach.
But don’t panic if you are still in tech. Markets do not move in straight lines. There will be bounces for you to switch out of tech/growth stocks.
But to repeat, if you are in quality tech giants (and are in this long term) you may want to hang in there.
Look at buying value stocks
So, where should investors switch their focus to? As I said last month, growth stocks have peaked in relative performance against value stocks. And I would be turning my attention to value plays.
What value stocks? Start with financials. Banks are beneficiaries of rising rates and yields. Typically, in the early stages of rate hiking cycles, bank profits benefit from net interest margin (NIM) expansion.
Energy is another sector. There is deep value in many energy companies. They are generating a lot of cash flow – particularly at these prices for oil and gas – and they pay good dividends.
Look at the materials sector too. Names in this space should also be early rate hiking cycle beneficiaries on the back of higher inflation.
Favour Europe and Japan over the US
The European and Japanese markets have a greater representation of value stocks than the US.
Consequently, their market price-to-earnings (PE) and price-to-book (PB) ratios are lower than the US.
Their earnings yields are also higher while the yield gaps (that is, the earnings yield minus the 10-year government bond yield) are wider.
Look at China in Emerging Markets
Indeed, I would treat China as the preferred proxy play for Emerging Markets. Here are a few key reasons why:
- It’s almost half the MSCI Emerging Markets Index anyway;
- It has one of the lowest inflation profiles in the Emerging Markets, which means less upward pressure on interest rates. Indeed, it has been cutting interest rates when others are raising rates or talking about raising rates;
- It has one of the highest yield gaps in favour of stocks in the Emerging Markets
From a value perspective, Chinese stocks have been oversold. The CSI 300’s PE and PB ratios are trading at the low end of their historical ranges.
And that fits the global theme of pivoting to value stocks.
Singapore proves defensive in ASEAN
Singapore will prove to be a bulwark in Southeast Asia. The key to this is it has the most attractive yield gap in favour of stocks among the ASEAN-5.
Within Singapore, I like the banks, which have been leading and driving the outperformance of the Straits Times Index year-to-date.
And the reason is, again, value. They are the best “value plays” within a “value market.”
