Investing

Value Stocks Look More Attractive as a Hard Landing Looms

Tim Fries

Published: September 27, 2023 6:55 am

On September 20th, the Fed skipped another interest rate hike, opting to hold it in the 5.25 – 5.50% range. This was despite inflation reheating in August, beating the expected 3.6% forecast by a 0.1% rise. However, the Fed’s preferred inflation gauge, core CPI, remained in line with Dow Jones polling expectations, at 4.3% over the year.

Holding the interest rate at the present level suggests that the Fed is counting on the hiking lag effect to start working rather than to further destabilize the banking sector. On the downside, the lag may work too much. The Fed Chair, Jerome Powell, hinted as much at last week’s press conference.

“I’ve always thought that the soft landing was a plausible outcome… ultimately, this may be decided by factors that are outside our control at the end of the day, but I do think it’s possible,”

Choosing to say “possible” instead of probable is telling. Of the three recessions in the last 40 years, in 1990, 2001, and 2007, soft landings were also eagerly anticipated but failed to materialize. According to Fed Vice Chair, Alan Blinder, only one durable soft landing occurred during the post-WWII period, which happened in 1995.

Moreover, a soft landing seems even less plausible, given the depletion of household savings. Per Bloomberg, excess savings for the bottom 80% returned to the pre-lockdown level of March 2020.

The federal funds rate was in the 0.00 – 0.25% range until the new hiking cycle began in March 2022. This translates to a macro landscape ripe for hard landing. The question is, how could investors approach it?

Value Stocks Before Hard Landing Rolls Over?

Of the many investments available, value stocks are for the long haul, more heavily scrutinized in the intermediary periods between bull and bear cycles. They represent companies trading below their intrinsic value, combining a company’s earning potential and underlying assets.

These stocks, such as Proctor & Gamble (PG) or Taiwan Semiconductor (TSM), are typically well-established with solid fundamentals. Therefore, as modestly valued, value stocks have a lower height to fall from in a hard landing scenario.

Another way to look at value investing is through market spreads. This year, the difference between the valuations of different stocks has increased, as expressed by their price-to-earnings (P/E) ratios.

Expectations from lower inflation and AI hype dominated H1 2023, boosting biotech stocks. However, as reversal is looming on the macro horizon, it is followed by value resurgence, according to Rob Arnott, founder of Research Affiliates.

“It is wonderful for people who have enjoyed the growth run and been light on value to have a third chance to rebalance and take advantage of bargains,”

Rob Arnott in Bloomberg interview

The latest 10-year Treasury yield surge at 4.55%, the highest level since October 2007, suggests that this rebalancing is coming. Investors took home the Fed’s “higher for longer” message, with a 40% chance for another hike by the year’s end.

Going long for discounted value stocks has been perceived as the go-to remedy in this economic environment.

This article originally appeared on The Tokenist