Inflation and the Value vs Growth Rotation: What the Literature Documents

Value beats Growth in inflationary regimes — but not for the reason most narratives claim. The mechanism is duration, not virtue: Value stocks have shorter cash-flow durations and therefore lower sensitivity to the real-rate increases that accompany inflation tightening cycles.

When inflation rises and central banks tighten, real Treasury yields rise and the discount rate applied to distant cash flows rises with them. Growth stocks — whose value is concentrated in cash flows ten or fifteen years out — lose more multiple than Value stocks, whose cash flows are nearer in time.

The Value-Growth rotation is one of the most persistent stylised facts in equity markets. The empirical record is well-established: Value outperforms during inflation overshoots and tightening cycles, Growth outperforms during disinflation and easing. The literature has identified the mechanism — duration of cash flows — and decomposed the rotation into its constituent factors. This article walks through what Cohen-Polk-Vuolteenaho 2003 documented, what the 2022 cycle confirmed, and why the rotation is more about discount rates than about company quality.

The duration framework

The duration framework predicts a specific behaviour. In a regime with stable or falling real rates, Growth multiples expand and Value lags. In a regime with rising real rates — typically the second half of an inflation cycle once central banks respond — Growth multiples compress and Value catches up. The 2008-2021 era was the longest sustained falling-real-rate period in post-Volcker history; Growth dominated. The 2022 cycle, with the largest single-year real-rate shock since 1997, produced the sharpest Value rotation in two decades.

What 2022 confirmed

The Russell 1000 Value index returned roughly minus 7% in 2022, while the Russell 1000 Growth index returned roughly minus 29%. The 22-percentage-point gap was the largest annual Value-Growth differential since 2000-2001, and it coincided with the largest real-rate move since the TIPS market opened. The mechanism was uniform across sectors: high-multiple growth tech (Cathie Wood ARK funds, ratio Russell 1000 Growth to Value) compressed by 30-40%; banks, energy, and materials — Value sector concentrations — held up. The Federal Reserve raised rates by 425 basis points; the 2-year U.S. real Treasury yield rose from minus 4% to plus 1.5%. Equity market valuation and real rates documents the broader multiples-real-rates relationship.

The 2022 episode is a clean test of the duration hypothesis because it isolates the real-rate channel. Earnings did not collapse — S&P 500 reported earnings stayed roughly flat — and corporate fundamentals were broadly stable. The market’s response was almost entirely a discount-rate adjustment. Value held up because its cash-flow stream was less sensitive to the new discount rate; Growth fell because it was more sensitive.

The structural factor decomposition

Asness, Frazzini, Israel and Moskowitz (2015, Journal of Portfolio Management) decomposed the Value premium across multiple dimensions and tested its persistence. Their framework separated pure cross-sectional Value (cheap-relative-to-fundamentals stocks) from sector tilts (Value sectors are concentrated in financials, energy, materials, utilities). They showed that pure Value persists across decades and across markets, while sector tilts fluctuate with macro regimes. The structural reading is developed in the macro-financial implications of structural inflation. In inflationary regimes, the sector tilt amplifies the cross-sectional effect: financials benefit from higher net interest margins, energy and materials benefit from commodity-price pass-through. 100 years of stock data traces the sector-level cycle behaviour over the broader sample.

The mechanism by which financials benefit during inflationary tightening is worth isolating. Banks earn the spread between funding costs (deposits, short-term borrowing) and asset yields (loans, bonds). When the yield curve steepens during the early phase of a tightening cycle — long rates rising faster than short — the spread widens and net interest income rises. Energy and materials firms benefit through a different channel: their revenue tracks commodity prices that are themselves driving the inflation print, while their cost base is dominated by fixed capital and labour with shorter price-setting cycles. The net result is operating-margin expansion in the early-to-middle phases of an inflationary cycle, before second-order labour-cost adjustments compress margins back toward equilibrium.

Arnott, Cornell and Kalesnik (2021, Journal of Portfolio Management, “Reports of Value’s Death May Be Greatly Exaggerated”) tackled the 2008-2020 underperformance of Value head-on. Their decomposition showed that the entire Value-Growth gap of that decade could be explained by multiple expansion in Growth — not by deteriorating Value fundamentals. Once the real-rate regime reversed in 2022, the multiple compression in Growth delivered the catch-up Value had been missing for a decade. The fundamentals of Value firms had been stable; only the macro discount rate had moved against them.

The intangibles complication

The implication is that the duration mechanism is more robust than the price-to-book proxy used to identify Value. Studies that adjust for intangibles — capitalising R&D and brand investment — recover a Value premium in the post-2008 sample that the unadjusted P/B ratio missed. This adjustment matters most for the Value-Growth comparison in the technology and pharmaceutical sectors, where intangibles dominate balance-sheet measures.

The dividend stock subset

A subset of Value — high-dividend-yield stocks — has its own inflation literature. Dividend payers have shorter implicit duration because the cash distribution is immediate, but they face two crosswinds in inflationary regimes: their dividends grow slower than nominal CPI in the short run (sticky payout policies), and rising real rates compete with their yield. The empirical record over 1970-2024 shows high-dividend portfolios outperforming the broad market modestly during the 1973-1981 inflation episode but underperforming during the 2021-2024 episode, partly because the latter included more rapid real-rate hikes than dividend policy could match. Dividend stocks and inflation protection covers this sub-case in detail.

The geographic dimension also matters. European Value indices have historically carried higher dividend yields and lower growth-stock weight than U.S. Value indices, which has produced a different rotation profile. In the 2022 episode, MSCI Europe Value outperformed MSCI USA Value on an absolute basis because the European composition was more concentrated in financials and energy, two sectors that benefited disproportionately from the rate-hike cycle and the energy supply shock. The same duration mechanism applies, but the sector-weight differences amplify the effect for European Value over its U.S. counterpart.

What the rotation does not say

The Value-Growth rotation is a relative-return phenomenon, not an absolute-return one. In 2022, Value held up better than Growth in relative terms but still posted negative absolute returns. The mechanism is mechanical: when discount rates rise, all equity multiples compress; the only question is by how much. Growth compresses more, Value compresses less, but neither expands in real terms during a tightening cycle of the magnitude observed in 2022. The rotation is also not a forecast: documenting that Value has outperformed Growth in past inflationary regimes does not establish what will happen in the next one, since composition of Value and Growth indices changes over time as sector rotations reshuffle the underlying constituents. Companies and pricing power covers the cross-cutting mechanism through margins.

For investors comparing the rotation across regimes, the broader frame is in the inflation regimes pillar, and the underlying real-rate trajectory in real vs nominal interest rates. TIPS and inflation-linked bonds covers the fixed-income side of the same real-rate mechanism.

For the broader inflation framework, see the complete inflation guide. Inflation and your savings connects the equity rotation analysis to the broader portfolio context.

Last updated — 7 May 2026