Growth vs. value in different interest rate environments

Jonathan Boyar, director of Boyar Value Group and advisor to the MAPFRE AM US Forgotten Value Fund

Most consumers are well-aware of the effect that interest rates—both short- and long-term—can have on their expenses. Consumers with credit card debt pay interest based on where short-term interest rates are (plus other factors including an individual’s credit score). Yields on 30-year mortgages—the preferred mortgage product of almost 90% of U.S. homebuyers—loosely track the path of 10-year U.S. Treasury rates.

But some investors may not be as well-versed in how interest rates affect stocks, particularly when weighing the differences between value and growth equities. Generally speaking, growth stocks perform relatively better in low interest rate environments, while value shares often lead when 10-year Treasury rates are 4% or higher. Between 3%-4%, history shows, is where the equation roughly balances out between growth and value shares.

This interest rate effect on value vs. growth stocks makes logical sense: when rates are low, earlier-stage/expanding companies are more willing and able to tap credit markets to facilitate their growth. Conversely, when interest rates are higher, the capital that many growing companies rely upon (including those that are not yet profitable) to fund their expansion becomes more costly. Furthermore, the price investors are willing to pay for growth stocks tends to be sensitive to expectations of cash flows well into the future, which become more significantly discounted in higher interest-rate backdrops.

In response to elevated—and not so transient—inflation, the Federal Reserve’s aggressive rate hiking cycle that started in March 2022, with 11 hikes ranging from 25bps to 75bps each, bringing the fed funds rates from 0.25% to 5.5% in less than 1 ½ years—the fastest rate hiking cycle since the 1980s. During this span, the 10-year yield surged from under 2.5%, briefly jumping above 5.0% last October. Since then, however, the 10-year underwent a sudden retracement, as the Fed has paused hiking interest rates, and expectations have shifted to interest rate cuts on the horizon in 2024.

We find it unlikely that the Fed will go back to periods of ultra-low rates like we experienced since the end of the Great Financial Crisis and during the COVID-19 pandemic. The current consensus among most Fed officials is that short-term rates will likely close out 2024 in a 4.5%-5.0% range, and none of the Fed officials foresees short-term rates going much below 2.5% even over the longer run. Meanwhile, the normalization of 10-year yields above 3% (currently ~4.0%) seems to suggest that—in contrary to a long period of growth outperforming value between the Great Financial Crisis and the COVID-19 pandemic while rates were historically low—value shares may be primed for a durable resurgence.