Performance of value stocks was much better in 2022 compared with the performance of growth stocks

During the course of last year 2022, one of my key forecasts was fulfilled, namely that value stocks should show a significantly better performance than growth stocks.

Value stocks are represented by companies from more traditional industries, with corporate fundamentals such as revenues, earnings and cash flow growing at a rather slower pace. At the same time, these corporate fundamentals are generally positive, and companies from this sector usually also pay a decent dividend. On the other hand, growth stocks are represented by companies from rather new and progressive industries such as technology, where their revenues usually have a strong tendency to grow very quickly, however, earnings and cash flow are often strongly negative. Therefore companies from this sector also usually do not pay any dividends. The current market value of growth companies is therefore based on the expectations of positive earnings and cash flow in the future. As the dynamics of their corporate fundamentals, unlike value companies, are expected to have steep future growth, growth companies have traditionally traded on average at some valuation premium compared to value stocks.

But back to last year, 2022, in which my bet on preferring value stocks over growth stocks really paid off handsomely. Indeed, the global index of value stocks fell "only" by 10% last year, while the global index of growth stocks fell by a rather dramatic 29%. The relative outperformance of value stocks compared to growth stocks was a respectable 19% last year!

I see several key fundamental drivers that led to this massive outperformance of value stocks last year. First, there were the valuations. At the end of 2021, P/E of value stocks was 9.2x, while that of growth stocks was 19.4x. The valuation premium of growth stocks over value stocks was therefore 112% at the end of 2021. At the same time, this valuation premium was significantly above the long-term historical average, and it was clear to me that sooner or later this valuation premium would have to be substantially reduced as part of the mean-reversion process. At the end of last year, 2022, P/E of value stocks was 7.7x and for growth stocks it was 13.9x. The valuation premium of growth stocks therefore fell by a full 31 percentage points to 81%. However, I believe that this current valuation premium is still too high, and its continued normalization somewhere to around 50% should contribute to the significant outperformance of value stocks during this year 2023 as well.

The second driver behind the outperformance of value stocks last year was the steep rise in interest rates, the likes of which the current generation of investors have not experienced in their entire careers. For example, the most important interest rate from the overall perspective of global financial markets – the yield to maturity on the 10-year US Treasury Bond – rose by a truly unprecedented 2.4 percentage points last year from 1.5% at the end of the year 2021 to 3.9% at the end of 2022. And at the same time, it is true that growth stocks are primarily long-duration assets, which are far more sensitive to interest rate movements compared to value stocks, because the most of shareholder value through earnings, cash flow and dividends will be generated much further into the future.

The third driver was the obvious realization of my global stagflation scenario, when, on the one hand, the world economy began to struggle with the highest inflation in the past four decades, and on the other hand, the dynamics of the world economy began to slow down significantly. This development last year had, and will continue to have, a much greater impact on growth companies on a relative basis than on value companies. As a result, it became clear that the market expectations built into the prices of growth stocks in particular regarding the enormously fast growth of corporate fundamentals in the following years were too high and too optimistic. At the same time, it also became clear that while anti-pandemic measures and lockdowns were huge tailwinds for some business models, the reopening of economies and the return of social life to a relative normal, on the contrary, paradoxically caused a slowdown in their growth (headwinds).

And finally, the fourth driver that had an effect on US stocks in particular was the end of some anti-pandemic fiscal measures, under which ordinary Americans received huge amounts of cash contributions (stimulus checks) from the Federal government. Indeed, large numbers of Americans dumped this cash into the stock market, and this extraordinary marginal market demand drove the stock prices of some of the most popular stocks to truly absurd and unprecedented valuation levels. Last year, however, the situation reversed and the NYSE FANG+ index of the largest US technology companies fell dramatically by a striking 40%.

I am now currently betting on the rotation from growth to value stocks to continue as I believe that the fundamental factors described above will very likely have a strong impact on global equity markets during the course of 2023 as well.