Brandes Letter- Could Inflation be A Tailwind for Value Stocks

Brandes Letter: Could Inflation be A Tailwind for Value Stocks?



MARCH 2021

Dear Clients and Friends,

The last few months have been encouraging for value investors, with the Russell 1000 Value Index outperforming the Russell 1000 Growth Index by over 5% year to date and by over 13% for the six months ending February 28, 2021.1 After a decade of very tepid economic growth and low or declining inflation in many parts of the world, an increasing number of economists are now expecting more robust growth thanks to the potential for further economic reopening, record government stimulus and increased consumption from pent-up demand during the pandemic. Many economists are also expecting higher levels of inflation, with some debate as to the magnitude or duration of this inflation.2

At Brandes, we do not base our investment decisions on macroeconomic forecasts such as interest rates or inflation predictions. However, it’s interesting to note that based on historical data, periods of above-average or increasing inflation have tended to benefit value stocks’ relative performance vs. growth stocks, as well as the performance of Brandes’ U.S., Global and International portfolios relative to their benchmarks.

Can increasing inflation help sustain value’s recent recovery? We believe so.

Today’s Environment and Historical Perspective

Beyond the increase in COVID-19 vaccinations and an improving economic backdrop, we believe rising inflation/interest rates could provide a tailwind to value stocks. Additionally, a material increase in interest rates may be a risk to the broader equity market as well as to fixed income, which in the past has generally provided some offset during equity market pullbacks. In a recent survey by Bank of America, global fund managers cited higher-than-expected inflation as the biggest risk to the overall equity and bond markets.3

We are now starting to see rising bond yields, with inflation breakeven4 in the bond market also signaling increased inflation expectations. Given their historical correlations with inflation and, interest rate movements, we believe the current environment bodes well for value stocks, and investors may benefit from increasing their value allocation. Exhibits 1 and 2 show the positive relationship between the U.S. Consumer Price Index, interest rates and global value stocks.


1 Source: Russell via FactSet as of 2/28/21.
2 Source: Third Covid-19 Stimulus Package Could Jolt U.S. Growth, Revive Inflation in 2021; The Wall Street Journal; published 3/10/21.
3 Source: Bank of America Global Fund Manager Survey, published March 16, 2021.
4 Difference between nominal and inflation linked yields - Market expected inflation.


Exh 1 and 2

When we delved further into periods of above-average or increasing inflation, we found the following interesting data points:

1. Globally, value has outperformed growth in periods of above-average or increasing inflation by an annual average of 100 to 220 basis points since 1985.

Table 1

Source: MSCI, World Bank, 12/31/1984 to 12/31/2019. Average annual relative performance. Past performance is not a guarantee of future results. One cannot invest directly in an index. Global inflation represented by inflation in the consumer price index from the World Bank. Average inflation rate is for the period 12/31/1984 to 12/31/2019. Annual returns from the MSCI World Growth Index were subtracted from annual returns of the MSCI Value Index. A positive result indicates the value index outperformed and a negative result indicates the growth index outperformed. It is possible for one index to outperform another but still experience a negative absolute return. The MSCI World Growth and Value Indices were launched Dec 08, 1997. Data prior to the launch date is back-tested (i.e., calculations of how the index might have performed over that time period had the index existed). There are frequently material differences between back-tested performance and actual results. Annualized returns for 12/31/1984 to 12/31/2019: MSCI World Growth 9.67%; MSCI World Value 10.32%.

2. Similarly, in the United States, value stocks have outperformed in periods of above-average or rising inflation since 1979.

Table 2

Source: FTSE Russell, World Bank, as of 12/31/2019. Average annual relative performance. U.S. inflation represented by inflation in the consumer price index from the World Bank. Average inflation rate is for the period 12/31/1978 to 12/31/2019. Annual returns from the Russell 1000 Growth Index were subtracted from annual returns of the Russell 1000 Value Index. A positive result indicates the value index outperformed and a negative result indicates the growth index outperformed. It is possible for one index to outperform another but still experience a negative absolute return. The Russell 1000 Growth and Value Indices were launched January 31, 1987. Data prior to the launch date is back-tested. Annualized returns for 12/31/1978 to 12/31/2019: Russell 1000 Growth 11.60%; Russell 1000 Value 11.99%.

Behind the Correlation

So what drove the positive correlation between value stocks’ performance and interest rate and inflation movements? We believe there are a variety of reasons:

1. Financials: Financial firms are the largest component of many value indices, and generally benefit from a higher and more upwardly sloping yield curve because:

  • They are able to borrow short duration (deposits) and lend longer duration, potentially boosting the spread between the rates they pay on their liabilities (deposits) and the rates they earn on their assets (e.g., mortgages, loans, other investments).
  • Higher rates have the potential to benefit their shorter-term investments.

2. Cyclical stocks: Value stocks in general (including financials but also industrials, energy, etc.) tend to be economically sensitive. A rising rate environment has tended to correlate with a strengthening economy, which in turn has historically been good for the economically sensitive value stocks.

3. Sentiment: Based on our observations, during times of significant economic uncertainty, such as those experienced during a trade war and a pandemic, investors are willing to pay a premium for the visibility/prospects provided by growth stocks, which tend to be less economically sensitive than value stocks. As the economy strengthens (and inflation rises), investors typically become more comfortable buying economically sensitive value stocks as their prospects improve.

4. Discount Rate: Rising interest rates typically increase the discount rate with which long-duration growth stocks5 are valued. A higher discount rate used in calculating the present value of distant cash flows for growth companies means those cash flows are worth incrementally less compared to value stocks’ more immediate cash flows.

Brandes Strategies During Periods of Rising Inflation

Historically, Brandes strategies have tended to outperform their benchmarks during periods of rising inflation.

1. Brandes U.S. Value has had stronger relative performance in periods of above average or increasing U.S. inflation.

Table 3

Source: S&P, World Bank, as of 12/31/2019. Average annual relative performance net of management fees. Please see the accompanying U.S. Value Equity composite performance presentation. U.S. inflation represented by inflation in the consumer price index from the World Bank. Average inflation is for the period 12/31/1991 to 12/31/2019. Annual returns of the S&P 500 were subtracted from annual returns of the Brandes U.S. Value Equity composite. A positive result indicates the strategy outperformed and a negative result indicates the benchmark outperformed. It is possible for a strategy to outperform its benchmark but still experience a negative absolute return.  


5 The present value estimate of growth stocks tends to be mostly driven by earnings/cash flow far into the future (due to the respective companies’ high growth or potentially not earning anything in the short term), which makes these stocks long duration.


2. Brandes Global Equity has also done better in periods of increasing or above average inflation.

Table 4

Source: MSCI, World Bank, as of 12/31/2019. Average annual relative performance net of management fees. Please see the accompanying Global Equity composite performance presentation. Global inflation represented by inflation in the consumer price index from the World Bank. Average global inflation for the period 12/31/1984 to 12/31/2019. Annual returns of the MSCI World Index were subtracted from annual returns of the Brandes Global Equity composite. A positive result indicates the strategy outperformed and a negative result indicates the benchmark outperformed. It is possible for a strategy to outperform its benchmark but still experience a negative absolute return. 

3. Brandes International Equity has seen much stronger performance during periods of above average or increasing inflation.

Table 5

Source: MSCI, World Bank, as of 12/31/2019. Average annual relative performance net of management fees. Please see the accompanying International Equity composite performance presentation. Global inflation represented by inflation in the consumer price index from the World Bank. Average global inflation is for the period 12/31/1990 to 12/31/2019.  Annual returns of the MSCI EAFE Index were subtracted from annual returns of the Brandes International Equity composite. A positive result indicates the strategy outperformed and a negative result indicates the benchmark outperformed. It is possible for a strategy to outperform its benchmark but still experience a negative absolute return. 

As bottom-up investors we do not select our investments based on a macroeconomic scenario, but rather on each company’s fundamental characteristics. This being said, should inflation rise, we believe our portfolios are well positioned due to their value-oriented nature.

Looking Ahead

After a long and difficult period for value investing, the overall economic environment seems to be favoring value. The past several months have seen returns for value stocks outpace returns for growth stocks as interest rates have climbed.6 While the prospects of our portfolios do not rely on the directions of interest rates or inflation, we believe the current environment bodes well for value stocks given their historical correlations with inflation and interest rates, and more importantly, their current valuations compared to growth stocks. Even after their recent outperformance, value stocks continue to trade at what we consider appealingly high discounts compared to growth stocks.7 We believe there is still room to go for value’s performance relative to growth.

Additionally, the potential of increased regulations for high-flying technology companies remains a distinct possibility. As technology companies make up a significant portion of growth indices, their share-price movements can greatly affect the overall returns of these indices.8 Therefore, while inflation may indeed provide a welcome tailwind for value investments, there are other compelling reasons to consider value investments and Brandes’ portfolios at this time.

Thank you,
Brandes Investment Partners


6 MSCI and FactSet, https://www.treasury.gov/. Growth and value stocks represented by MSCI ACWI Growth Index and MSCI ACWI Value Index for the period 08/30/2020 to 02/28/2021. Interest rates represented by 10 Year US Treasury Rate for the period 8/4/2020 to 3/9/2021.
7 Source: MSCI via FactSet as of 2/28/21. Value stocks: MSCI ACWI Value; growth stocks: MSCI ACWI Growth. Valuations based on price/earnings (value 20.9x vs. growth 41.0x), price/book (value 1.8x vs. growth 6.4x) and price/cash flow (value 10.9x vs. growth 25.0x).
8 As of 2/28/21, the technology sector accounted for 45% of Russell 1000 Growth and 34% of MSCI ACWI Growth. Source: Russell, MSCI via FactSet.

Basis Point: 1/100 of 1%.
Correlation: A measure of the extent to which two variables move in relation to each other.
Discount rate: Interest rate used in cash flow analysis to determine present value of future cash flows.
Price/Book: Price per share divided by book value per share.
Price/Cash Flow: Price per share divided by cash flow per share.
Price/Earnings: Price per share divided by earnings per share.
Yield: Annual income from the investment (dividend, interest, etc.) divided by the current market price of the investment.
Yield Curve: A graphical comparison of the relationship between interest rates for loans of various maturities with similar credit quality. A typical yield curve slopes upward to reflect higher interest rates for longer maturities.
The U.S. Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
The consumer price index used by World Bank reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly. The Laspeyres formula is generally used.
The MSCI EAFE Index with net dividends captures large and mid cap representation of developed market countries excluding the U.S. and Canada The MSCI World Index with net dividends captures large and mid cap representation of developed markets.
The MSCI World Value Index captures large and mid cap securities across developed market countries exhibiting value style characteristics, defined using book value to price, 12-month forward earnings to price, and dividend yield.
The MSCI World Growth Index captures large and mid cap securities across developed market countries exhibiting growth style characteristics, defined using long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.
The MSCI ACWI Value Index captures large and mid cap securities across developed and emerging markets exhibiting value style characteristics, defined using book value to price, 12-month forward earnings to price and dividend yield.
The MSCI ACWI Growth Index Index captures large and mid cap securities across developed and emerging market countries defined using long-term forward earnings per share (EPS) growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend, and long-term historical sales per share growth trend.
The Russell 1000 Value Index with gross dividends measures performance of the large cap segment of the U.S. equity universe. Securities are categorized as growth or value based on their relative book-to-price ratios, historical sales growth, and expected earnings growth.
The Russell 1000 Growth Index with gross dividends measures performance of the large cap growth segment of the U.S. equity universe. Securities are categorized as growth or value based on their relative book-to-price ratios, historical sales growth, and expected earnings growth.
The S&P 500 Index measures equity performance of 500 of the top companies in leading industries of the U.S. economy.
MSCI has not approved, reviewed or produced this report, makes no express or implied warranties or representations and is not liable whatsoever for any data in the report. You may not redistribute the MSCI data or use it as a basis for other indices or investment products.
Past performance is not a guarantee of future results.
One cannot invest directly in an index.
The information provided in this material should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any security transactions, holdings or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Strategies discussed are subject to change at any time by the investment manager in its discretion due to market conditions or opportunities. Market conditions may impact performance. The performance results presented were achieved in particular market conditions which may not be repeated. Moreover, the current market volatility and uncertain regulatory environment may have a negative impact on future performance. The Brandes investment approach tends to result in portfolios that are materially different than their benchmarks with regard to characteristics such as risk, volatility, diversification, and concentration. Diversification does not assure a profit or protect against a loss in a declining market. International and emerging markets investing is subject to certain risks such as currency fluctuation and social and political changes; such risks may result in greater share price volatility.
Unlike bonds issued or guaranteed by the U.S. government or its agencies, stocks and other bonds are not backed by the full faith and credit of the United States. Stock and bond prices will experience market fluctuations. Please note that the value of government securities and bonds in general have an inverse relationship to interest rates. Bonds carry the risk of default, or the risk that an issuer will be unable to make income or principal payment. There is no assurance that private guarantors or insurers will meet their obligations.
The foregoing reflects the thoughts and opinions of Brandes Investment Partners® exclusively and is subject to change without notice.
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