(Bloomberg) -- With odds of a hard landing rising just as inflation is set to re-accelerate, this is the time for investors to offload their expensive growth shares in favor of value stocks, says Rob Arnott, founder of smart-beta pioneer Research Affiliates.
Inflation is set to climb near 5% by year-end thanks to base effects, said Arnott, which will be a tailwind for cheap shares that have been neglected all year as investors dove headlong back into Big Tech stocks.
“The illusion of tumbling inflation helped to fuel the surge in growth relative to value,” he said in an interview on Bloomberg Television. “Now we’re experiencing the reverse of that.”
A longtime factor investor, Arnott has preached the value trade through thick and thin. But lately, his message has started to resonate as 10-year bond yields surge past 4.5% for the first time since 2007. A strategy that goes long cheap stocks and short the opposite is set for its best month in nearly a year, a Bloomberg index shows.
Arnott, whose firm runs about $130 billion, points to the market’s valuation spreads, which widened anew this year as expectations for lower inflation and optimism about artificial intelligence lifted the multiples of beloved tech stocks. The last two times those spreads hit similar levels in 2020 and 2021, a value resurgence followed.
In his view, the catalyst for a reversal could be anything from resurgent inflation to rising rates and recessionary fears. Any of these tailwinds are likely to boost the appeal of value shares, which offer the safety of near-term cash flows and modest valuations.
“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,” he said before his television interview. “You don’t often get that. So I look at the current environment as being a just near perfect environment for value.”
To him, consumer prices are set to rise at a faster pace as they will now be compared to a lower base in the second half of 2022. Demand is also getting a boost from employees working from home, which is helping them save money for discretionary spending like vacations.
Even then he says the Federal Reserve should be cutting rates as a recession isn’t needed to slow inflation and more attention should be paid to supporting the private sector in boosting supply.
“We’re laying a foundation of relatively high odds of a recession and increasing odds of hard landing — and unnecessary hard landing,” he said on television. “If the notion is let’s raise until there’s evidence of a slowing, you’ve baked in several quarters of slowing by the time you notice.”
©2023 Bloomberg L.P.