Higher Rates & Value Investing: Examining the Complex Relationship

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Brewster discussed Higher Rates & Value Investing: Examining the Complex Relationship. Here’s an excerpt from the episode:

Bill: Yeah. I don’t know, like Green Brick has worked great and the stock has worked as the business has worked. It doesn’t seem like a broken market, but he’s a lot smarter than I am.

Tobias: All right. Let me throw out another one. Tyler’s got a couple of good ones here.

Jake: He’s on fire today.

Tobias: Yeah. “Do you guys think the value factor will perform better with a period of sustained higher rates?”

Jake: It’s above by pay grade, Toby. You take this one.

Tobias: Yeah, that’s an interesting question. It doesn’t really make sense that higher rates should help equities. But I think that higher rates certainly hurt firms that have got back ended cash flows, so the growthier stuff that isn’t doing anything now and things that are highly levered, which you could maybe say value firms tend to be more highly levered, I don’t know. It’s hard. Buffett said following the last big period of inflation, whether it was 1970s or 1980s something like that that he would have rather been in the asset light businesses that had pricing power than in the received wisdom.

The common wisdom was that you want to be in the asset intensive stuff, because the assets go up in value, ignoring the fact that you have to periodically replace the assets, which means that you’ve got to stump up. You got to find the money to buy them at a higher price than you bought them previously. And so, you might earn money on your assets for a period of time, but then it’s illusory, because when you go to buy, you got to pay more. It’s a tough one. Certainly, low rates didn’t help, but let’s try high rates and see what happens.

[laughter]

Bill: Well, look, I think to the extent that rates would cool the labor market and to the extent that labor runs through value firms income statements, I think it could help. I noticed Met Coal is in some value screens. Met Coal seems to me to be a big beneficiary of fiscal stimulus. If rates stay high, I could see an argument why you wouldn’t build more facilities and you may not expand your operations. So, I think that the combination of fiscal spending and high rates could help some of these value stocks a lot, because I think it may restrict supply from coming on.

Tobias: Coal has had a pretty good run over the last 12 months.

Bill: Yeah. But I’m thinking the same thing. I have this theory that high rates might actually create inflation, and I think it’s because it may reduce aggregate supply and I think that may help value, but maybe not.

Jake: What about giving all these savers a little bit more spending power too? And grandma’s savings account now gives her four before that she can go buy things with that she wasn’t when it was at zero.

Tobias: It depends a little bit on the composition of the economy. Like, if it’s mostly net savers versus– Maybe that doesn’t work out. Maybe you have to have that– Maybe the savings has to equal the borrowings, I don’t know. I don’t know.

Bill: I think the composition of the economy is maybe one reason to be a little less scared of oil than were in the 1970s. Oil going higher will actually do wonders for taxes, which was not historically the case. It didn’t used to bring much money into the US economy. Now it could.

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