Will Value Stocks Keep Outperforming?

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Value stocks are outperforming growth stocks in 2022. So far this year, the value-heavy TSX and Dow Jones indexes have beaten the NASDAQ-100, which is heavily weighted in high-growth tech stocks.

This year, central banks are raising interest rates, and that’s taking a bite out of tech stocks’ growth. In the meantime, value sectors like energy and utilities are rapidly rising. In this article, I will explore some reasons why value stocks are outperforming in 2022 and attempt to assess whether they can continue doing so.

Interest rates rising

The main reason why value stocks are outperforming in 2022 is because interest rates are rising. High interest rates lessen the present value of assets’ future cash flows. They affect all assets in this way, but the percentage impact is greater the higher the growth rate. So, when interest rates rise, a company that’s growing earnings at 30% per year takes a bigger hit than one that’s growing earnings at 1% per year.

When interest rates rise, stocks in general tend to fall. But value stocks fall a lot less than growth stocks do. Because their growth is lesser, there is less future earnings power for higher interest rates to take a bite out of.

There are even some value sectors that actively benefit from rising interest rates. Banks like Toronto-Dominion Bank (TSX:TD)(NYSE:TD) make money by issuing loans. The higher the interest rate, the more profit banks earn on mortgages and other loans. In 2020, when interest rates were near zero, mortgage rates went as low as 2%. Today, TD is advertising five-year fixed mortgages above 4.1%. The bank might issue fewer mortgages with these higher rates, but it will earn higher profit margins on the loans it issues.

Tech earnings disappoint

A second factor contributing to value’s outperformance this year is a slew of disappointing earnings releases from the big tech giants. In February, all the big tech firms reported fourth-quarter earnings, and a few of them disappointed investors. Some stocks went down 40% or more. A few weeks ago, the same companies reported first-quarter earnings, and, again, there were some big disappointments among them. For example, Amazon stock fell 14% in a single trading day after posting a multi-billion-dollar loss.

Banks like TD aren’t exactly operating without risk today, but they are not losing money. Compared to tech companies losing billions, they look like surefire bets. This fact may be leading investors to buy them in greater numbers than they would have in the low interest days of 2020 and 2021.

Foolish takeaway

Judging by macroeconomic factors, it looks like value stocks have a few more months of outperformance ahead of them. Interest rates are still going up, and tech companies are still disappointing investors. This year, people who hold value stocks are partying like it’s 1999, while the rest of the market is suffering big drawdowns. Nobody knows how long the value party can go on for, but the possibility of sustained outperformance throughout 2022 is very real.

The post Will Value Stocks Keep Outperforming? appeared first on The Motley Fool Canada.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Fool contributor Andrew Button has positions in The Toronto-Dominion Bank. The Motley Fool recommends Amazon.

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