The S&P 500 is off to a choppy start in 2022. Though the index sits less than 3% below its all-time high, a notable shakeup in leadership has occurred below the surface. From the start of the year, value stocks have outperformed growth stocks by roughly 7%. This shift comes as participants begin to price in the realities of the year ahead. The Fed is preparing to ramp up its fight against inflation and the unprecedented fiscal stimulus of the last two years is now a thing of the past. Without monetary and fiscal support, growth stocks face a more uncertain future. By contrast, many value stocks are likely direct beneficiaries of the inflationary environment.
As indicated by the December report, inflation looks to be anything but transitory. Consumer prices increased 7% year over year and 5.5%, excluding food and energy. Though in line with forecasts, the readings marked the highest level of inflation since 1982. While temporary supply disruptions continue to be a major driver of price increases, we are beginning to see stickier pockets of inflation form. As an example, shelter costs have risen by 4.1% over the past year. If allowed to persist, this type of inflation can prove tough to break. As such, the Fed is on course to raise rates 3 to 4 times this year and may soon begin to engage in quantitative tightening. The long end of the yield curve has moved higher in response, raising the discount rate for stocks in the process.
Markets are also staring down a sizeable fiscal drag in 2022. The government doled out trillions of dollars in stimulus over the past two years that will not be repeated this year. The Biden Administration's Build Back Better plan has struggled to advance through congress and will be significantly scaled-down if it is able to limp across the finish line. Without further fiscal stimulus, consumers may begin to spend down the savings they have built up over the course of the pandemic. Earnings for consumer-focused companies could be pressured this year as a result.
It is early, but the shift to value from growth is pronounced, and we believe it can continue. In our portfolios, we have worked to reduce exposure to growth stocks that trade at high price to earnings multiples while at the same time increasing exposure to more value-oriented stocks trading at lower multiples. We will continue to be on the lookout for companies with pricing power. We anticipate that companies that can profitably pass on price increases to customers will be particularly attractive in the year ahead.
Preston May, CBE®
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S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.