Central banks around the world are embarking on an interest rate-cutting cycle. But what does this mean for growth and value companies?
Rate Cuts Affect
Central banks, like the Bank of England and Federal Reserve, cut interest rates to stimulate the economy, making borrowing cheaper for businesses and consumers, which can encourage spending and investment.
Lower rates also reduce loan costs and can boost stock prices, as companies can grow more easily with cheaper access to funds.
On the flip side, lower rates tend to feed inflation, which means that cutting too deep could actually harm the economy.
In theory, rate cuts should benefit both investment styles.
As rates fall, expected future profits become more valuable, which boosts company valuations.
But there are some more specific ways each style is impacted by lower rates.
Growth
Growth stocks are typically companies expected to grow profits and cash flows faster than the market.
This means falling rates can have a much larger positive impact on the value of future cash flows relative to value companies.
As a result, growth companies typically have higher valuations (think high price-to-earnings ratio) than the broader market. But these higher valuations do increase the investment risk if profit growth fails to materialise.
Value
Value stocks are typically companies with lower valuations (think low price-to-earnings ratio) than the broader market.
This can often be due to low rates of expected future growth, market pessimism or operating in a cyclical industry at the bottom of the cycle.
Lower interest rates can lead to an uptick in broader economic activity, which can boost consumer spending and increase revenues and profits for these companies.
An uptick in economic activity can also lift future profit expectations and investor confidence.
All of these factors can lead to higher valuations.
Growth or Value
In the relatively recent past, growth stocks have outperformed their value peers.
Looking forward, a prolonged period of lower rates should provide growth stocks with a comparatively stronger tailwind.
However, growth companies also tend to carry more risk, largely due to lofty growth expectations that might not materialise.
Where We Are
The rate cutting cycle is underway, which should favour growth stocks.
But if 2024 has taught us anything, it’s that expectations can change.
At the start of 2024, markets were pencilling in six interest rate cuts throughout the whole year. Fast-forward to November, and there can only be a maximum of three rate cuts this year.
This shows that markets can get it wrong sometimes too. It’s not clear how long the current cycle will last, or how fast cuts will come through.
This just highlights the importance of a diversified portfolio, as this way you will likely always have something working in your favour.
If you would like to talk further about growth and value investing as part of your portfolio, arrange a Discovery Call with one of our FCA authorised wealth managers [Here]
This article is for informational purpose only. It does not constitute finacial, tax or legal advice, nor is it a recommendation to buy, sell or hold any investment. Past performance is not a guide to the future, investments rise and fall so investors could make a loss. No view is given on the present, future value or price of any investment and investors should form their own view on any proposed investment.