As Rates stabilize, growth stocks may rebound

by Russ Koesterich, CFA, JD, Portfolio Manager, Blackrock

Russ Koesterich, managing director and portfolio manager, of the Global Allocation team discusses the criteria for growth stocks to bounce back.

From the November peak to the recent trough, U.S. large cap growth stocks lost more than 30%, a decline on par with the pandemic induced bear market. And while growth has managed to rebound from the May lows, year-to-date most indexes are still down 23%. Growth is still trailing the S&P 500 by roughly 10% and nearly 17% versus comparable value indexes (see Chart 1).

What will it take for growth to rebound? I’d cite three criteria: sustainable valuations, a decelerating economy, and a more stable rate environment. I believe the first two criteria have been met and the third is close.

Unsustainable

While comparisons to the late ’90s were somewhat misplaced, it is fair to point out that too many growth companies were trading at unsustainable valuations before this year’s decline. That said, while many early growth names are still vulnerable, the mega-cap names that dominate the tech and growth indexes appear more reasonably priced.

The NYSE FANG+ Index of mega-cap tech names has given up its entire pandemic valuation premium. The index is now cheaper than it was at the pandemic low and the market bottom reached in late 2018, both excellent times to buy growth stocks.

Aside from elevated valuations, tech and other growth names were hurt by the rotation into cyclical and value stocks. The rotation was fueled by optimism for a stronger economy. After years of sluggish growth investors rushed to take advantage of the stimulus induced expansion that lent a tailwind to value names. That trend is now ending.

Even assuming we avoid the recession many investors fear, economic growth is slowing. A survey of economists by Bloomberg shows 2023 GDP estimates falling from 2.5% in March to 2% today. As economic growth slows, investors typically revisit growth stocks able to generate consistent earnings.

The last question revolves around interest rates. Higher rates impact the discount rates investors apply to future earnings. As a result, growth companies, particularly the most speculative, typically reprice the fastest when the discount rate rises. This is particularly true when rates rise rapidly. Looking back at the past 10-years, small increases in long-term rates have been immaterial to growth’s relative performance. However, sharp spikes in long-term rates have been associated with significant growth underperformance, as has been the case all year.

Reconsider high-quality growth

While high inflation and an aggressive Federal Reserve suggest long-term rates have yet to peak, we have already witnessed a significant adjustment. Rates are likely to revisit the May highs, but I don’t believe they’ll go much higher. If rates do stabilize, this removes a key headwind for growth.

But there is one caveat: Investors should remain cautious on the most speculative growth stocks, i.e., those with no likelihood of near-term earnings. Instead, focus on high quality, profitable names. If economic growth and rate increases continue to slow, investors are likely to rediscover the merits of these companies.

Russ Koesterich, CFA, is a Portfolio Manager for BlackRock's Global Allocation Fund and the lead portfolio manager on the GA Selects model portfolio strategies.

Total
1
Shares
Previous Article

Fed Goes Bigger

Next Article

Time to Pursue All Weather Investing

Related Posts
Read More

David Burrows Discusses Leadership Themes, What The Market Data Is Telling Us, And Asks: Is This A Rally Within An Ongoing Bear Market, Or The Early Days Of A New Bull Market?

David Burrows, President and Chief Strategist at Barometer Capital Management presents his "Barometer Reading" on financial markets, the…
Read More

Picton Mahoney Q3 2022 Investment Review & Outlook: Inflation looks set to fall, the economy is likely to waiver, but stocks may rally

by David Picton and Team, Picton Mahoney Asset Management Copyright © Picton Mahoney Asset Management
Subscribe to AdvisorAnalyst.com notifications
Watch. Listen. Read. Raise your average.