Happy New Year to Value transcript

Welcome to RBC’s Markets in Motion podcast, recorded January 11th, 2022. I’m Lori Calvasina, head of US equity strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

Today in the podcast, we review our latest thoughts on the fierce rotation we’re seeing from Growth to Value and Cyclicals so far in 2022. Two big things you need to know: (1) We think it’s premature to declare the rotation out of Secular Growth into Value and Cyclicals over yet. (2) We’ve continued to get questions about what to own in a rising rate environment – our answer is pretty simple – sell what’s expensive (a list still dominated by Tech) and buy what’s cheap (a list still full of commodities and Financials). 

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Now, let’s jump in.

Takeaway #1: We think it’s premature to declare the rotation out of Secular Growth into Value and Cyclicals over yet.

  • We’ve been anticipating a strong start to the year for Value and Cyclicals, followed by a pivot back to Growth/Secular later in the year – normally, Value beats Growth ahead of the first Fed rate hike and when GDP is trending above average as 2022 is expected to be, but Growth beats Value after lift off and when GDP is trending below average which consensus economic forecasts see as a risk for 2023.
  • There are six things we’re watching on these positioning trades that we think will help us identify when it’s time to pivot back to Secular Growth, most of which are still supportive of the Cyclical Value trade for the moment.
    • First, the timing of hikes – if the Fed lifts off in March, the pivot back to Growth will happen earlier than the mid-year timing we’d been penciling in, but we’ve still got a little time before that milestone, especially considering equity investors have been behind the curve on Fed timing. Recall that before the holidays, but after the December Fed meeting, 54% still expected lift off in 2Q of 2022 in our investor survey.
    • Second, valuations – Growth still looks expensive vs. Value and Secular Growth sectors still look expensive vs. Cyclicals.
    • At the sector level, Energy and Materials still look cheap and Tech still looks overvalued. Financials is a sector we’re keeping an eye on right now – it’s gotten much closer to neutral on our model.
    • hird, positioning – as of January 4th, the latest data available, Nasdaq futures positioning still looked very stretched among asset managers based on data from CFTC, and had actually rebounded back to levels close to 2013-2014 and early 2021 highs. We need to see that unwind before the froth in Growth is truly out.
    • Those three indicators all tell us there’s still some room in Value and Cyclicals, even though it’s probably less room than what we expected a month ago.
  • I mentioned six indicators… here’s there other three we’re watching:
    • First, earnings revisions – the rate of revisions to the upside actually favors Growth right now b/c Energy trends have weakened while Consumer Discretionary trends have improved. We’ll see if that sticks in the upcoming reporting season.
    • Second, flows – it’s just too early to get a read here yet, but it’s worth noting that last year Value flows got off to a stronger start than Growth but the Value trade lost steam as Value flows starting to fade heading into the summer.
    • Third, 10 year yields – we’ve been bumping up again recent highs, but our rate strategy team sees further upside to 2.2% at year end 2022. If he’s right on that, ultimately there’s another leg in the Value trade.

Moving on to takeaway #2: We’ve continued to get questions about what sectors to own in a rising rate environment.

  • The chart we keep sending to people is one we’ve published many, many times – it shows how Financials and Energy – last week’s two top performing sectors in the S&P 500 – have shown the strongest tendency to outperform when the 10 year yield is rising since the Financial Crisis, along with Materials and Industrials.
  • But we’ve also been telling investors we wouldn’t just focus on sectors in addressing this question.
  • Rather, as we highlighted in December, the cheapest stocks tend to outperform the most expensive stocks when interest rates are rising.
  • Today, Energy and Financials remain well represented on the list of the cheapest names, which we define as those that fall into the bottom quintile within the R1000 on a simple FY2 P/E ranking, while Technology remains well represented on the list of the most expensive names, which we define as those that fall within quintile 1.
  • Once that changes, it will help to illustrate how the opportunity in certain Value sectors has been exhausted and how a new opportunity has returned to certain Growth sectors. But we’re just not there yet.

That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for deep dives into specific sectors with RBC’s team of equity analysts.