Capital Investment Advisors

Value Investing Continues To Hold Up In 2022

How are you feeling about the world, the market, the economy, and everything else? It’s a little rough out there for everyday folks who want to save for a happy retirement and leave the world a little better than they found it. We’re done with a pandemic that doesn’t seem done with us, inflation is making all our stuff cost more, Russia seems bent on reminding us that bad people don’t learn the lessons of history, and stock prices have been, for lack of a better term, upsetting. 

If you study the economy, there’s an analytical side and there’s a “how are people feeling” part of the equation. One might call it the anthropological factor of economics. Milton Friedman and John Maynard Keynes might’ve been too busy waxing poetic about the complexity of stabilization policy or the foundation of modern macroeconomics to worry about feelings, but it’s an area of interest for me.

Most Americans right now are not feeling so good about the economy. The University of Michigan Consumer Sentiment Index tells us much about subjective mood. On a scale that goes up to one hundred and twenty, sentiment is down at fifty.

For some context, before COVID hit, this same consumer sentiment was near one hundred. COVID knocked it down to the high sixties and then once the world started to reopen it ascended back to the ninety range. Then, with inflation in 2022, our confidence has dropped like a stone. Here we are today, at the lowest point we’ve seen in the fifty-plus years we’ve been keeping track of the numbers. 

A lot plays into this, but the number one factor is rising prices. We’re not talking about “nice to have” items. We’re talking about “need to have” items. You can’t get to work if your car is out of gas. You need shelter and food. Forty-seven percent of U.S. consumers blamed inflation for their lack of confidence because it has eroded their living standards.

If the prices for items you spend money on are going up by fifteen percent per year but your wages are only going up by two percent, you’re losing purchasing power. Additionally, if the place you have your money invested in has been heading lower, now those items you purchase aren’t just fifteen percent more expensive, they may be thirty percent or more.

The reason we invest instead of throwing a bag of cash into various rat holes is because we want our money to be able to keep up with inflation. I’m not judging rat holes. My buddy has a few. If the U.S. economy ever collapses, I’ll be begging him to let me into his bunker but until then I will use historical trends as a guide. That is the crux of almost all investing. We invest our money with a goal it will stay far enough ahead of inflation to protect our purchasing power. 

Inflation is high, markets are bad, and consumer sentiment is reflecting that negativity. 

Here’s who it’s hitting—everyone. This University of Michigan Consumer Sentiment Index shows that it’s affecting folks across income, age, education, geographic region, and political affiliation. It’s being felt by stock owners, homeowners, renters, and everything in between. This is a national phenomenon. You pull up to the gas pump, and it takes an ungodly amount to fill up the tank. Will you be able to make ends meet?

The bear market we’re in the middle of isn’t helping, either. As a reminder, a bear market is a decline of at least twenty percent from the recent high. Every bear market has its specific cause. 

The 2000 Tech Crash was an overinflated bubble of empty promises. In the late 1990s that led to all sorts of new companies and jobs being created only to vanish six to twelve months later. Money hit the exits and companies and jobs disappeared at a massive rate that led to the Nasdaq being down seventy-five to eighty percent. Is the market right now as bad as that? I don’t think so. 

During that 2000 crash, the price-to-earnings ratio was around the thirty range, which means investors were paying thirty times earnings for the overall market. Today, price-to-earnings is around sixteen or sixteen and a half. There are pockets of today’s market that remind me of 1999, like crypto, but the overall picture does not. 

What about the Financial Crisis of 2007 and 2008? That period was, arguably, much worse than what we’re seeing today. Home loans were given out unwisely and with wild abandon, triggering a massive overbuilding of homes. As soon as the banks realized they couldn’t keep it up, lending standards went through the roof, housing values crashed, and the entire economic system fell on its head. Today, housing prices are high, but we still have an undersupply of homes. 

The St. Louis Fed measures how much of a household’s income goes toward debt service. Higher is bad, lower is good. Normally, it lands in the ten to thirteen percent range. Today’s households are relatively unlevered. Debt service bottomed out at close to eight because rates are low. That’s important because it allows for a cushion before we even have to worry about returning to the not-normal range. That’s very different from the Financial Crisis.

How about 2020 and the pandemic? That, to me, was the scariest economic time because it was so uncertain. The U.S. essentially shut everything down, as did most other countries around the globe. We had stay-at-home orders in every state. I had no idea what that would do for company earnings. How would they continue to pay their debt? It was very scary. That’s why the market fell almost thirty-five percent in about a month.

Are today’s problems as bad? I don’t think so. Today’s economy is almost too strong. The labor market shows very low unemployment. We’re seeing two job openings for every one person looking. There’s still too much money in the economic system. That is beginning to reverse as the Federal Reserve raises rates and pulls money out of the economic system. We were spoiled for years with insanely low rates, but we can do just fine with them raised to a more normal four-to-six percent range.

Looking at the broader anatomy of a bear market, through the first half of 2022 we’re still floating around that negative twenty percent mark for the S&P 500. If you go back to 1961 and look at the last twelve bear markets, you’ll see that’s below average.

It typically takes about 1.7 years to get a full recovery back to the previous peak, but if you go back to look at each of those twelve markets you’ll see that thirty percent of the recovery occurred within the first thirty days. The takeaway is clear. You have to be there, invested, to be part of that recovery. 

What’s happening today is that there’s a real fear and anxiety, so people feel inclined to sit it out. I can’t tell you what to do, but I can say that doing so puts you in jeopardy of missing the recovery that comes quickly, without any notice. I don’t want that to happen to you.

I’m tired of talking about what’s not working. What is working? 

We’ve spent a lot of time talking about the difference between growth and value companies. Now that we’re halfway through 2022 the message is clear—value companies have generally held up better than growth companies. But, what exactly does that mean? What companies fall within the value index? 

No offense to Keynes, but I’ve been spending so much time talking about the macroeconomic, big-picture level version of the market that I’ve neglected to get down into the weeds.

Value companies are down less than half versus their growth counterparts. As an example, if you compare the Russell 1000 Value Index vs. the Russell 1000 Growth Index you’ll see the data. As a refresher, value investing is a style that focuses on companies that often trade at prices lower than what they’re worth. That’s how this style got its name. 

Think about companies in the consumer staples sector. What comes to mind? Things we use every day like food, beverages, household goods, and hygiene products. 

For the most part, these products are the must-haves. Demand doesn’t change much even when there’s a price increase. Think about gasoline. We drive about the same even when gas prices go up because we still have to get to work and back.

Value companies aren’t the most exciting assets, per se, so why do investors tend to hold them? This is because established and consistent success often allows companies to pay dividends—a steady stream of income that could make up for a slower trajectory of growth. 

In contrast, growth companies are flashier and sexier. They may not currently generate any revenue, but their future earnings potential is high. Every penny the company makes for what could be the first decade or so ends up being reinvested back into the company to grow. That means there is typically no dividends for shareholders.

What kind of companies am I referring to? Almost half of the growth companies are in the information and technology sector. Then, there are consumer discretionary companies, and finally, communication. In actuality, all three sectors contain technology companies. That means seventy to eighty percent of the Russell 100 Growth Index is made up of tech. 

From a yield perspective, even in this tough market, value stocks are just about doubling what growth stocks are doing. The price-to-earnings ratio for value companies is about forty percent lower than their growth company counterparts. In fact, value companies currently have a lower price-to-earnings ratio than their ten-year average, so it’s even inexpensive on a historical basis. 

And, if you look at EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, to evaluate the operating performance relative to its size, value companies are trading at about nine times EBITDA compared to growth trading at about fifteen times EBITDA. That means value is trading at about a forty percent discount compared to growth. 

The bottom line is that when we enter into choppy waters, as we’ve seen in 2022, typically the areas with the most excess are punished the most. That means the growth indices, the Nasdaq, and cryptocurrencies. When we look at the Russell 1000 Value Index, we see those companies typically hold up much better. 

If you want to play defense against a challenging economy, you can try a few things. Sometimes owning bonds makes sense. They’re paying at least some interest today. You can exit the market completely, which I typically don’t recommend. Lastly, you could own value, dividend-oriented stocks as a way to get through this unpleasant time. There are many options when it comes to investing. Do your research and determine what is best for you.

Times are tough, but I don’t want you to panic. Stay calm and stay the course. While we can’t always look at the past to predict the future, we can use history as our guide. Historical trends are in our favor. With the bear markets listed above, the market recovered and there’s no reason to think it won’t do so again. 

This is provided as a resource for informational purposes and is not to be viewed as investment advice or recommendations.  This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. The mention of an investment is provided to you for informational purposes and as an example only and is not to be considered investment advice or recommendation or an endorsement of any particular investment.  Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved.  The information provided is strictly an opinion and for informational purposes only and it is not known whether the strategies will be successful. Investment decisions should not be made solely based on information contained herein. There are many aspects and criteria that must be examined and considered before investing.  This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.  The views and opinions expressed are for educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions.

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