The ‘new normal’ proves elusive: time for the old normal

  • The triggers for the ongoing rotation in markets may be geopolitical events, but there are signs that the shift is enduring as inflation takes hold and interest rates rise
  • Growth investors were extrapolating a continuation in the ‘new normal’ but we are now seeing a return of the ‘old normal’
  • The operational performance of traditional value sectors, such as Oil & Gas, Mining and Financials, is now far stronger than fashionable growth stocks
  • The valuation gap between value and growth stocks is still wide, while investor positioning also favours value stocks, suggesting that this rotation could have legs

Since the start of the year, markets have shifted dramatically. The growth stocks that performed so well over the past decade have sold off, while more traditional value stocks have started to revive. At first glance, this rotation is simply a knee-jerk response to external factors such as Covid-19 and the Russia-Ukraine war. However, on closer inspection, there is far more to the rotation than one-off events, strengthening our view that it could persist for some time.

The build-up of inflationary pressures has driven up interest rate expectations, providing impetus to this rotation. Growth stocks tend to price in long-dated cash flows that become worth far less when they are discounted back at higher interest rates. Conversely, stocks that offer strong short-term cash flows become more attractive. This has been a factor in the stronger performance of the cash-generative stocks that we hold in the abrdn Equity Income Trust in recent months.

Geopolitical events may have been the initial triggers for this rotation, but it is now being supported by a growing gap in operational performance. Many traditional sectors, such as Oil & Gas, Mining and Financials, have had far stronger earnings momentum and cash flows than the growth stocks that were previously so fashionable.

When Covid-19 first struck, investors extrapolated a ‘new normal’ in economic activity, resulting in a widening in the gap between growth and value stocks. The lofty valuations of growth stocks required a continuation of the benign conditions that had helped these companies during lockdown. Once the economy started to normalise, as lockdowns eased, investors became aware that operational performance was shifting back in favour of more traditional value sectors. The valuation gap was too big to ignore.

The resulting rout in in some of the previously hot segments of the stock market has been significant. The sell-off started with concept stocks, with big ideas but little or no profitability, but has subsequently extended to more mainstream technology stocks such as Netflix, Amazon and Google.

Part of the problem for many growth stocks is that investors extrapolated long-term growth trends from their short-term strength during the pandemic. The ‘new normal’ appears to have faded as lockdowns have ended. Streaming services have been losing subscribers, online retailers have been losing sales as consumers re-discover physical shops, while there remain questions over how companies are using data, threatening the business model of some social media companies.

Earnings momentum

This environment provides a useful backdrop for the abrdn Equity Income Trust, allowing us to scour the entire UK equity market for attractively valued stocks with positive cash flows and earnings momentum, capable of thriving as inflation reasserts itself. Our quantitative model highlights companies across the portfolio screening well for positive earnings revisions and compelling valuations.

We see many traditional sectors coping well with the more challenging macro backdrop. The momentum behind the strong performance of the Oil & Gas and Mining sectors has come from a combination of recovering demand post Covid-19 and contracting supply due to the crisis in Ukraine. At the same time, the shift to electric vehicles has increased demand for raw materials such as lithium, copper and nickel, while ESG (Environmental, Social, Governance) pressures have constrained new capital expenditure. The shift from ‘new normal’ to ‘old normal’ is also noticeable in the changing political agenda, with increasing focus on the cost of living and energy security, underlining the importance of these traditional sectors. All of this has the potential to drive earnings and cash flows, justifying a significant overweight position in the portfolio.

This environment also favours a heavy weighting in Financials. Higher inflation is driving up interest rates, with Financials the natural beneficiary, particularly those whose interest income will directly benefit. Banks have retained significant balance sheet provisions following Covid-19. As a result, we have been adding to our UK banks weighting.

Equity income renewal?

The resurgence in traditional sectors is helping the UK equity income sector to regain momentum. Bemused by the rout in growth stocks, investors are asking ‘where next?’. In an uncertain environment, with many growth stocks having plummeted, investors can “touch and feel” dividends, providing an important and reassuring component of the total return investors aim for. Tastes may change, but the attraction of dividends apparent.

Company selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Important Information

Risk factors you should consider prior to investing:

The value of investments and the income from them can fall and investors may get back less than the amount invested.

  • The value of investments and the income from them can fall and investors may get back less than the amount invested
  • Past performance is not a guide to future results.
  • Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
  • There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
  • As with all stock exchange investments the value of the Trust shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
  • The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
  • The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
  • Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
  • The Company may charge expenses to capital which may erode the capital value of the investment.
  • The Alternative Investment Market (AIM) is a flexible, international market that offers small and growing companies the benefits of trading on a world-class public market within a regulatory environment designed specifically for them. AIM is owned and operated by the London Stock Exchange. Companies that trade on AIM may be harder to buy and sell than larger companies and their share prices may move up and down very sharply because they have lower trading volumes and also because of the nature of the companies themselves. In times of economic difficulty, companies listed on AIM could fail altogether and you could lose all your money.
  • The Company invests in the securities of smaller companies which are likely to carry a higher degree of risk than larger companies.

Other important information:

Issued by Aberdeen Asset Managers Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom. Registered Office: 10 Queen’s Terrace, Aberdeen AB10 1XL. Registered in Scotland No. 108419. An investment trust should be considered only as part of a balanced portfolio. Under no circumstances should this information be considered as an offer or solicitation to deal in investments.

Find out more at by registering for updates or by following us on Twitter or LinkedIn.