Growth, Value and Interest Rates ….
Growth, Value and Interest Rates …. What is the real relationship ?
During the past few months, market participants have been dumping so called “growth stocks”, arguing that higher interest rates are negative for this sector or these type of stocks.
The following chart compares the relative performance of the MSCI US Growth versus MSCI US Value (a proxy for Growth Stocks) and the 10-year US Bond Yield (right and inverted scale).
Source : MSCI, FRED, Deshima
The – negative – correlation is quite clear even on a daily basis for the last 14 months.
It is now well known that so called “growth stocks” have a longer duration than other stocks in general. It simply means that the expected cash-flow of dividends and/or earnings is a little far away, more in the future than for other companies.
It is also well known that long duration bonds are more sensitive to interest rates than shorter duration (sorry to be trivial).
The obvious conclusion is that longer duration stocks decline when interest rates are rising…
That is true but everything being equals…. When interest rates move up and down, the characteristics of a bond do not change, so the price logically moves down or up.
The “everything being equals” condition is much more difficult to apply to stocks. If we continue a little theory, the exact (inverted) relationship for stocks is not interest rates R but the term R minus G (the Graal of valuation models, G being the growth in fact).
If R is trending up with G (and G is in nominal terms if R is nominal), there are no impact in theory.
That is why that over the last 32 years the correlation between 10 years US rate and relative performance of MSCI US Growth versus MSCI US Value is unconclusive:
Source : MSCI, FRED, Deshima
A zoom in on the year 2000 is very interesting to that extent: (right scale is NOT inverted)
Source : MSCI, FRED, Deshima
In 2000, contrary to now, the correlation was negative. Growth stocks outperformed Value stocks as rates were rising from 4.5% at the end of 1998 to more than 6.5% early 2000. Conversely, growth stocks underperformed Value stocks after 2000 with rates declining back to 4%.
Another example: in 2017/2018 when rates started to increase from 1.5% to 3%, Growth stocks continued to outperform Value stocks.
Source : MSCI, FRED, Deshima
As a conclusion, interest rates are not an indicator of direction for Growth stocks versus Value stocks.
