Hawkish Fed gives value stocks a second wind

Investors are recalibrating their portfolios to account for a more hawkish Federal Reserve, as signs that the central bank is ready to pull out the stops in its fight against inflation has shaken up markets in the first week of 2022.

Yields on the benchmark 10-year US Treasury are on track for their biggest weekly gain since September, 2019, while technology and growth stocks have tumbled and investors snapped up shares of banks, energy firms and other economically sensitive companies.

The action is broadly reminiscent of how markets started 2021, when the rollout of vaccines for the coronavirus boosted expectations of a US economic reopening. Yields slipped later in the year while the rally in economically sensitive shares slowed and investors returned to the big technology and growth stocks that have led markets higher for the last decade.

This time around, investors must factor in a Fed that is expected to raise rates at least three times this year as it battles surging consumer prices. This could weigh on tech and growth stocks, as higher borrowing costs could erode their future earnings. The S&P 500 Value index has gained around 1 per cent for the year to date, while the S&P 500 Growth index has fallen around 4 per cent. The broader index was recently down around 1.7 per cent for the year.

Bob Leininger, a portfolio manager at Gabelli Funds, expects that trend to continue and is focusing more of his portfolio on financials, energy, and aviation stocks such as Boeing Co (BA.N) in anticipation of a broad resurgence in global travel.

“The Fed is serious about ending quantitative easing,” he said. “This is the year that we will start to see quantitative tightening and that will favor value stocks.”

While investors typically view a hawkish Fed with caution, equities have nevertheless tended to rise during past rate-hike cycles. The S&P 500 has risen at an average annualized rate of 9 per cent during the 12 such cycles since the 1950s and showed positive returns in 11 of those instances, according to data from Truist Advisory Services.

Expectations that the Fed will raise interest rates at least three times in 2022 will “cut down on speculation” in the market, said Lew Altfest, chief executive of Altfest Personal Wealth Management.

That will likely weigh on both deep value-oriented sectors like travel and energy that saw outsized gains in 2021, while at the same time hurting high-growth technology shares, he said.