Have Rate Hikes Tipped the Scales Toward Value Equities?

Higher capital costs may add fuel to value equities with shorter-duration cash flows. 

In the AI-led markets of recent years, companies with distant profit potential have been favored. But higher interest rates could change the equation and create a new advantage for value stocks, whose businesses tend to have more visible cash flows in the shorter term.

Equity investors are grappling with two big challenges in late 2026. First, AI’s pervasive influence is drawing a wider range of companies and industries into its orbit. Second, persistent inflation and expectations for further monetary tightening are driving bond yields higher. These trends are testing traditional diversification strategies. 

Fed Hike Resets the Equity Hurdle Rate

In the new diversification discussion, interest rates deserve attention. Rates have moved higher on the market agenda since the US Federal Reserve increased its policy rate in September amid growing concern about sticky inflation—the first hike since the post-pandemic declining trajectory that began in mid-2023. Other major central banks are also in tightening mode. 

History suggests that value stocks have been relatively resilient when rates rise. Our research suggests that US and global value stocks have outperformed growth peers three, six and 12 months after rate-hike cycles began (Display).

Why Do Higher Rates Help Value?

Higher rates aren’t the most favorable conditions for equity investors. As bond yields rise, bonds become more competitive with stocks, potentially weighing on equity valuations and returns. 

But the effects vary across equity styles. Lower interest rates push down the discount rate applied to future cash flows. That boosts the present value of future cash flows, which tends to favor growth stocks, whose valuations often depend more heavily on “long- duration” profits expected further into the future. 

Rising rates reverse that dynamic. Higher discount rates have a greater impact on distant cash flows, leaving long-duration growth stocks more exposed to changes in rates and capital costs. In contrast, many value companies derive more of their worth from visible “short- duration” cash flows over the next three to five years, making their valuations less dependent on distant assumptions.

Connecting the Dots: A Broader Case for Value

Today's market may be more sensitive to interest rates than many investors realize. In recent decades, the S&P 500 often rose alongside higher rates, particularly when cyclical sectors carried greater weight in the index. Today, growth stocks account for a much larger share of market capitalization, making changes in interest rates more consequential for market leadership and valuations (Display). In our view, that helps explain why value stocks may play a more important diversification role if rates remain elevated or move higher from current levels.

Yet despite evolving conditions, the research challenge hasn’t changed for active value investors. Capturing long-term return potential requires more than just identifying statistically cheap stocks. We believe a disciplined value investing process should be based on fundamental research that aims to identify businesses whose current prices understate the durability, timing and reinvestment potential of their free cash flows. As we see it, when capital is costlier, cash that arrives sooner carries more weight, while business models that rely on distant earnings face a higher burden of proof.

Balancing Exposures in the AI-Driven World

That lens can also help navigate other forces reshaping markets. The infrastructure that powers AI is increasing demand for power, data centers, semiconductor capacity and other physical infrastructure. This is creating opportunities both for companies involved in the AI build-out itself as well as businesses that provide the assets and services needed to operate AI infrastructure over the long term. Asset-heavy companies stand to benefit, including businesses in the value universe whose long-lived assets would be costly or time-consuming to replicate. Meanwhile, value stocks can offer resilience to AI disruption. Value stocks aren’t immune, but many are rooted in industries that either supply the build-out or are less directly exposed to technological displacement, from agriculture to aerospace.

Together, we believe these dynamics strengthen the case for broadening exposure to value equities. We see attractive value opportunities across sectors including healthcare, financials, real estate and industrials that are well positioned for a rising-rate environment and AI-driven market dynamics. In our view, active value investors may be particularly well equipped to assess these opportunities, given their longstanding focus on normalized earnings and cash-flow durability. This discipline can help distinguish cyclical businesses with sustainable profit potential from those benefiting from more transient conditions.

Growth companies with robust business models still have a place in diversified allocations. But portfolios that became heavily tilted toward long-duration growth during the low-rate era may benefit from selective exposure to value stocks backed by visible free cash flow, disciplined capital allocation and credible normalized earnings. Higher rates might have shifted the investment equation—and tipped the scales toward a more meaningful role for value in equity allocations.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.