SPDR espresso strategy | Value trading works even when interest rates rise

  • Value stocks have continued their strong rise in 2022 despite the rise in interest rates to discount future earnings.
  • If valuation compression continues to focus on growth stocks, value stocks may continue to be the right place to invest.
  • Investors should consider a selective approach to seeking strong exposure to value factors, as reflation is likely to be a volatile business.

Back in January, we published a note titled Value is Back and This Time It Could Be Here to Stay. In, we argued that the strong relative performance of the value factor in December 2021 is likely to continue in 2022. Since the beginning of this year, all three regional SPDR® MSCI Value ETFs have outperformed their respective market benchmarks.1


We highlighted this possibility because we believed that the main driver of markets would be the normalization of interest rate policy. The US Federal Reserve (“Fed”) and other central banks have been forced to phase out programs for quantitative easing of bond purchases and raise short-term target interest rates. This aims to combat high price inflation in the economy.

In this valuation, stock market rates are often used as the discount rate for future profits. Over the past decade, modern monetary theory (“MMT”) has led central banks to keep interest rates artificially low. This led to an increase in asset prices driven by rising earnings multiples. As shown in Chart 1, this phenomenon has disproportionately favored the valuation of growth stocks in European equities.

Appendix 1: Relative price-earnings ratio for FWD (last 10 years)

As the European Central Bank has signaled its willingness to follow the Fed on its journey away from MMT and towards a more normal interest rate environment, we have seen this growth rating premium flatten out. Meanwhile, the relative valuation premium is still above the +1 standard deviation of the long-term median. This suggests that the valuation of growth equities will continue to decline and that value equities may continue to be an interesting option.

Figure 2 shows how this year’s outperformance has been evenly distributed across sectors. SPDR® MSCI Europe Value UCITS ETF follows the MSCI Europe Value Exposure Select Index, which is sector neutral when rebalancing. This means that most of the relative performance is due to stock selection and not just differences in sector allocation. This is an important component of this type of investment. Investors can focus specifically on the factor without betting on a particular sector.

Appendix 2: Fed Fund’s interest rate and index return (6-month subsequent return)

We believe that the outperformance of the value factor year to date can only be the beginning. Especially in European equities based on the fundamental change in central bank policy expected in 2022. We would like to warn investors that this trading is unlikely to be without volatility. As such, we recommend a selective approach to seeking strong exposure to value factors. For example with the SPDR® MSCI Europe Value UCITS ETF.

How can an exposure selection strategy help investors play value while avoiding pitfalls?

Investors who use value strategies to take advantage of cheap stocks need to protect their portfolios against stocks. These are cheap for a reason. Value Exposure Select strategies, such as the SPDR® MSCI Europe Value UCITS ETF, enable investors to gain significant exposure to value factors. At the same time, they try to avoid value traps by applying light quality control. To learn more about this ETF and see its full performance history, please visit the fund page.

SPDR® ETFs offer a range of Value Exposure Select strategies worldwide, US and Europe that track the MSCI Value Exposure Select index family.

1 Source: Morningstar, pr. 31 May 2022

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