As Rates Stabilize, Growth Stocks May Rebound

Russ Koesterich, CFA profile picture
Russ Koesterich, CFA
3.44K Followers

Summary

  • 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.
  • Growth is still trailing the S&P 500 by roughly 10% and nearly 17% versus comparable value indexes.
  • As economic growth slows, investors typically revisit growth stocks able to generate consistent earnings.

Stock Market And Finance Concept - Yellow Up Arrow Symbol Glowing Amid Black Arrow Symbols On Black Background

MicroStockHub/iStock via Getty Images

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.

Global value vs. growth equities

Global value vs. growth equities (Author)

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.

This post originally appeared on the iShares Market Insights

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

Russ Koesterich, CFA profile picture
3.44K Followers
Russ Koesterich, CFA, JD, Managing Director and portfolio manager for BlackRock’s Global Allocation Fund, is a member of the Global Allocation team within BlackRock's Multi-Asset Strategies Group. He serves as a member of BlackRock's Americas Executive Committee. Mr. Koesterich's service with the firm dates back to 2005, including his years with Barclays Global Investors (BGI), which merged with BlackRock in 2009. He joined the BlackRock Global Allocation team in 2016 as Head of Asset Allocation and was named a portfolio manager of the Fund in 2017. Previously, he was BlackRock's Global Chief Investment Strategist and Chairman of the Investment Committee for the Model Portfolio Solutions business, and formerly served as the Global Head of Investment Strategy for scientific active equities and as senior portfolio manager in the US Market Neutral Group. Prior to joining BGI, Mr. Koesterich was the Chief North American Strategist at State Street Bank and Trust. He began his investment career at Instinet Research Partners where he occupied several positions in research, including Director of Investment Strategy for both U.S. and European research, and Equity Analyst. He is a frequent contributor to financials news media and the author of two books, including his most recent "The Ten Trillion Dollar Gamble."Mr. Koesterich earned a BA in history from Brandeis University, a JD from Boston College and an MBA from Columbia University. He is a CFA Charterholder.
Follow

Recommended For You

Comments (1)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.