New York – Investors were jolted last week by a stunning consumer price index report showing inflation surging more than anticipated in January, spurring the worst single-day stock market selloff thus far in 2023. A broad range of equities tumbled as investors fret over the Federal Reserve’s next policy moves.
The latest inflation data reveals prices rising at their fastest annual pace since 1981, dimming hopes that rate cuts could come soon. Markets are recalibrating forecasts, with fears mounting that more Fed tightening awaits. After logging a winning start to the year, stocks sank and volatility spiked.
Among the hardest hit have been popular technology and other high-growth stocks. With valuations stretched and profits often far in the future, these names are vulnerable to rising rates. But some left-behind value stocks offer rare bargains after steep underperformance last year.
Inflation Proves Stickier Than Expected
Inflation is proving to be stickier than policymakers had hoped amid still-strong economic momentum. While year-over-year consumer price gains are down from over 9% last summer, January’s 6.4% rise indicates rapid price increases nonetheless.
Stubborn inflation stems from resilient consumer demand despite higher costs weighing on households. Robust spending is leading companies to further lift prices in order to protect profit margins. An unusually tight labor market is also pushing up wages as businesses compete for workers.
“We expected disinflation to be quicker, broader, and larger by early 2023,” noted Bank of America economists. “However, resilient consumer demand, improving business sentiment, and lack of improvement in supply chains have led to inflation falling less than hoped.”
Fed Pivots to Tougher Stance
Prior to February’s inflation stunner, investors had grown confident that the Federal Reserve would start cutting interest rates as soon as this spring to support economic growth. Traders were betting on rate cuts totaling one percentage point or more before 2023 ended.
But Fed Chair Jerome Powell and other officials have pushed back on such aggressive easing bets. They maintain rates will need to stay higher for longer to fully tame inflation running well above the central bank’s 2% target. Markets were caught flat-footed by persistently high inflation that risks becoming further embedded.
Shorter-maturity Treasury yields rapidly repriced higher to reflect tighter Fed policy for longer. Meanwhile, rate-sensitive assets like high-valuation technology stocks tanked as markets braced for more protracted tightening.
Growth Stocks Face Storm Clouds
Popular technology and other high-flying growth stocks have stumbled badly to kick off 2023 after steep sell-offs last year snapped their powerful multi-year uptrends. Despite holding promise over the long-term, their stretched valuations leave them exposed amid Fed tightening shifting into higher gear.
Former market leaders like Nvidia, Amazon, and Tesla Motors have seen their stock prices essentially cut in half from 2021 peaks. The tech-centric Nasdaq 100 index sank nearly 33% last year in its worst annual performance since 2008. And the recently renewed slide in growth stocks signal additional volatility may await this year.
Rising rates diminish the value of future profits that growth companies aim to deliver. Higher capital costs also threaten to slow enterprise and consumer spending on big-ticket items like cloud services and electric vehicles.
With the Fed still laser focused on reining in the strongest inflation surge in over 40 years, growth stocks seem prone to additional pressure. However, more reasonably priced value stocks offering income and stability are back in the spotlight.
Time to Rotate into Value?
As growth stocks slide once more, undervalued and dividend-paying value stocks offer rare bargains after years of lagging market returns. Value names also serve as potential ballasts for investor portfolios during times of heightened volatility and economic uncertainty.
According to Bank of America Global Research, value stocks shockingly trailed growth equities by a massive 39 percentage points last year, an extreme level of dispersion. This sets the stage for potential mean reversion rotations into value in 2023.
Value stocks also sport improved earnings outlooks compared to early last year when recession fears dominated. Wall Street analysts project just 2% year-over-year profit declines for value stocks, markedly better than expected cuts approaching 10% then.
Leaning into neglected value plays trading at deep discounts to historical norms looks tactically prudent. Dividend payers also offer income during times of wavering share prices.
Top Value Stock Bargains
With markets seesawing and Fed policy still restrictive, historically cheap value stocks offer upside potential combined with downside cushion. Here are three top value stock bargains.
General Motors – Symbol GM
Iconic automaker General Motors faces both hurdles and opportunities amid a secular industry shift towards electric vehicles. Although the company has ambitious plans to convert a majority of its fleet to electric in coming years, GM must first weather near-term bumps like softening consumer demand.
But with its stock off nearly 50% from 2021 highs, much negativity appears priced in. GM now trades at ultra-low forward price-to-earnings ratio below 7 even as profits are seen expanding at double-digit annual rates ahead. The stock also sports a 3% dividend yield.
Given its still strong brands and improved cost profile after recent restructuring programs, investors with long time horizons can capitalize on GM trading at basement level valuations.
United Airlines Holdings – Stock Symbol UAL
Airline stocks face worries over oil price shocks, labor shortages, and possible recession hits to ticket demand this year. But legacy carrier United Airlines seems uniquely primed for upside as consumers increasingly take to the skies again after pandemic-related disruptions.
With unparalleled reach across the Atlantic and Pacific oceans along with mainland U.S. hubs, United is optimally positioned to capture resurgent global travel flows. Corporate travel also continues recovering to pre-virus levels, aiding premium seat bookings.
Although near-term turbulence lies ahead, United projects brisk long-term earnings growth following years of depressed profitability. Yet shares inexplicably trade at mid-single-digit forward P/E ratios, signaling skeptics abound. Once business travel normalizes further, United could rapidly ascend to new altitudes.
Vital Energy – Stock Ticker VTLE
While household technology names dominate financial headlines, small-cap oil and gas producers are raking in money amid elevated energy prices. Vital Energy represents an ideal but overlooked value opportunity to capitalize.
This Texas-driller has rapidly expanded its presence in America’s prolific Permian shale oil basin, more than doubling its size recently through acquisitions. With inflation boosting profit margins on pumped fossil fuels to their highest in over a decade, Vital Energy can fund generous shareholder rewards programs.
Trading at just 4 times forward earnings and cash flows, Vital Energy offers deep value and capital growth potential as management pays down debt. Its discounted valuation may also attract buyout interest from larger rivals consolidating across Texas oil fields.
Recession Fears Collide With Persistent Inflation
After achieving milestone gains since pandemic lows, stocks are suddenly facing formidable macro hurdles this year. While corporate profits remain resilient for now, concerns loom over how much additional tightening the economy can withstand before buckling under recessionary pressures.
But with the Fed’s inflation fight still underway, investor focus is starting to shift towards neglected value stocks offering income and inflation protection. As growth potential remains limited by higher rates for longer, it pays to get defensive via attractively priced value while preparing for further market turbulence ahead.
