As markets opened 2022, much attention has been paid to the return of the reflation trade as value stocks experienced a strong rally in December 2021 (see Figure 1). This is quite similar to one year ago, when value stocks rallied significantly through year-end 2020 and into Q1 2021. Investors are now questioning how long the current reflation trade will persist. To answer this question, we believe investors need to focus on the key catalyst driving this year’s move compared to one year ago.
Figure 1: Brinson Attribution by Sector (Portfolio vs. Market Benchmark)
At the end of 2020, the reflation trade was driven by the news that the first COVID vaccines would become available in 2021. This drove value stocks higher – which had been heavily discounted during the initial stages of the pandemic – on the belief that economic activity would pick up in 2021. While this did occur, the economic recovery stagnated a bit in the second half of the year as the Delta and then Omicron variants threatened economic reflation.
What is different this time around? The Federal Reserve (“Fed”) has determined that the economic data suggests the reflation trade must go forward in 2022. The Fed has announced a clear plan to pursue a normalisation of interest rate policy (i.e. reducing bond purchases and increasing the Fed Funds Target Rate) in 2022. This action should benefit value stocks, relative to growth, as their valuations are less sensitive to discounting cash flows, which occur as long-term interest rates rise.
The last time the Fed engaged in such a plan of interest rate normalisation, in 2016, value stocks experienced a strong rally, as seen in the trailing 6-month returns of the MSCI Value Exposure Select Index (see Figure 2).
Figure 2: Fed Funds Rate and Index Returns (Trailing 6-Month Returns)
In conclusion, we think Q1 2022 may provide investors with another opportunity to benefit from a rally in value stocks. We also believe the opportunity in value could sustain itself throughout the year, given the fundamental change in Fed policy expected in 2022. We would caution investors that this trade is unlikely to occur without volatility and thus we suggest investors use a selective approach to targeting strong value factor exposure, for example by using the SPDR® MSCI USA Value UCITS ETF.
How does an Exposure Select strategy help investors play Value while avoiding traps?
Investors using value strategies to take advantage of cheap stocks need protect their portfolios against stocks that are cheap for a reason. Value Exposure Select strategies such as the SPDR® MSCI USA Value UCITS ETF can allow investors to access strong value factor exposure, while seeking to avoid value traps, by using a light quality touch. To learn more about this ETF, and to view full performance history, please visit its fund page.
SPDR® ETFs offer a suite of Value Exposure Select strategies in World, USA and European exposures that track the MSCI Value Exposure Select family of indices.
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For Investors in Austria: The offering of SPDR ETFs by the Company has been notified to the Financial Markets Authority (FMA) in accordance with section 139 of the Austrian Investment Funds Act. Prospective investors may obtain the current sales Prospectus, the articles of incorporation, the KIID as well as the latest annual and semi-annual report free of charge from State Street Global Advisors Europe Limited, Branch in Germany, Brienner Strasse 59, D-80333 Munich. T: +49 (0)89-55878-400.F: +49 (0)89-55878-440.
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