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Over recent months, it has become increasingly clear that unprecedented levels of quantitative easing and extensive fiscal policy are feeding both an inflationary environment and an economic recovery.

Era of “growthflation” is a strong opportunity for value investors

Chris Hiorns Chris Hiorns Manager of the EdenTree Responsible & Sustainable Managed Income Fund
Opinion

Era of “growthflation” is a strong opportunity for value investors

Chris Hiorns

Chris Hiorns
Manager of the EdenTree Responsible & Sustainable Managed Income Fund

Over recent months, it has become increasingly clear that unprecedented levels of quantitative easing and extensive fiscal policy are feeding both an inflationary environment and an economic recovery. The Bank of England’s decision to raise rates to 0.25% is a strong indication that they no longer see inflation as transitory. The concern remains is that, in absence of a huge shock to the global economy, they may have fallen far behind the curve. With economic growth also expected to continue - investors must brace themselves for a new market paradigm; the era of growthflation.

Growthflation occurs when you get a spiral of strong demand leading to higher prices and wages leading to further demand strengthening. In this scenario, central banks should be expected to tighten monetary policy through the withdrawal of quantitative easing and raising interest rates until they bring the cycle under control. It is a marked change from what investors have become accustomed to over the previous decade of ultra-low interest rates and one which may see a reversal of fortune in the value vs growth debate.

It is fair to say that the previous decade has been a challenging one for responsible and sustainable value-oriented investors everywhere. Growth stock valuations have skyrocketed whilst, in relative terms, value stocks have lagged. The MSCI World Value Index has returned 210% since the end of 2011, compared to the 420% delivered by the MSCI World Growth Index over the same period.

This has prompted questions about whether value based approaches will ever generate strong enough performance in a rapidly changing market, given the rapid structural changes we are seeing in the global economy from digitisation to the shift towards greener business models. Yet, much of the performance in growth has come at the cost of ever higher valuations and remains largely dependent on the performance of a small handful of stocks, mostly centred on the FAANGS.

At the same time, the valuations of value and high yield market segments are still trading at around historic averages, despite the very low interest rate environment and the strong cyclical upturn in the global economy. Many of these companies are also in a position to benefit from changes in the global economy, or are well placed to maintain their strong market positions despite challenges from newer tech-based ‘disruptors’.

The first category includes companies from a wide variety of sectors. Companies like DS Smith and Greatview Aseptic are both benefiting from the shift away from disposable plastics to sustainable alternatives, while Royal Mail and PostNL are both capturing the growth in e-commerce. It also includes companies like Mersen and Prysmian who are helping to build new green energy infrastructure.

In the second category are sectors like banking where strong customer bases and physical infrastructure create a competitive moat that protects from disruptors, whilst technology advances allow them to simultaneously cut back costs. This sector is also well-positioned to benefit from higher inflation and rising yields, so too is the insurance sector which is already extremely attractive on valuation grounds. There are plenty of opportunities to purchase strong players on dividend yields in the high single digits, such as Talanx and Mapfre, both of which are also actively investing in green energy infrastructure.

Opportunities also abound in value-orientated defensive sectors that were left behind in the value cyclical rally at the start of 2021. This includes pharmaceutical companies like GlaxoSmithKline, which trades on low valuation multiples with strong cashflow and dividend policies and is also likely to benefit from an upsurge in non-Covid related treatments.

As we look ahead to 2022, the reality is that in terms of economic and financial conditions, as well as valuations, there has rarely been a better time to be a value-orientated investor in responsible and sustainable companies.  Whilst it is impossible to forecast when the “growth” bubble valuation will burst, we are entering a phase in which a value-led approach will once again have strong resonance in the market and the ability to offer extremely attractive risk and return profiles.

The views contained herein are not to be taken as advice or recommendation to buy or sell any investment or interest. The value of an investment and the income from it can fall as well as rise, you may not get back the amount originally invested. Past performance should not be seen as a guide to future performance. EdenTree is authorised and regulated by the Financial Conduct Authority and is a member of the Investment Association. Firm Reference Number 527473.

This content was originally posted on Investment week https://www.investmentweek.co.uk/opinion/4042279/era-growthflation-strong-opportunity-value-investors