Could Fall Weakness In Growth Stocks Bring Opportunity?

Russ Koesterich, CFA profile picture
Russ Koesterich, CFA
3.48K Followers

Summary

  • After a brutal six months, during which the Russell 1000 Growth Index fell more than 32%, growth stocks finally found a floor in June before rebounding.
  • September is not over and is rarely kind to investors.
  • A slower economy is, at least on a relative basis, supportive of growth stocks, which tend to command a higher premium when earnings growth is harder to find.

Stock Market Capital Gains Increasing From A Bull Market

Darren415

It didn’t last. After a brutal six months, during which the Russell 1000 Growth Index fell more than 32%, growth stocks finally found a floor in June before rebounding. While the rally was already running out of steam by mid-August, the real death knell occurred on August 26th. Federal Reserve Chairman Jerome Powell used his speech at the annual summer conference in Jackson Hole to put to rest any hopes for a quick end to the Fed’s tightening campaign.

Although tech and other growth stocks may suffer through more September volatility, the longer-term outlook is more encouraging. The economy is softening, not collapsing, valuations are more interesting and real rates have already adjusted. It’s worth recounting then why the summer rally faded, and fall weakness presents an opportunity.

Too much, too soon. After bottoming in June, tech and broader growth indexes surged 25%. Some segments, notably semiconductors and internet commerce, staged even bigger rallies, advancing 30% and 40% respectively. Given the magnitude of those gains, a pause was always likely. That the rally should stall in late August in the face of still tightening financial conditions and weak seasonality should not come as a shock.

The pivot will have to wait. The late summer sell-off accelerated once it became clear that the Fed had no intention of pivoting away from tighter monetary policy. Investors got the message and immediately began driving real -- or inflation-adjusted -- rates higher. Real long-term yields, already backing up before the conference, spiked to more than 0.80%, the previous high from June (see Chart 1). While higher real rates are a headwind for the broader market, they are particularly punishing for growth stocks, where earnings tend to be more concentrated in future years.

U.S. 10-year Treasury yield breakdown

US 10-Year Treasury Yield Breakdown

Refinitiv Datastream chart by BlackRock Investment Institute, Sep 05, 2022

More tightening already baked-in

September is not over and is rarely kind to investors. That said, looking further ahead, there is reason for optimism. Real rates have already priced in an aggressive tightening campaign. In less than a year, long-end real rates have risen by more than 200 bps. At current levels, real yields are roughly double last decade’s average. And while rates have risen, rate volatility has remained well below the summer peak. This is important as volatility in rate markets can be as damaging as higher interest rates. Finally, a slower economy is, at least on a relative basis, supportive of growth stocks, which tend to command a higher premium when earnings growth is harder to find.

Given this dynamic, I would use September weakness to add to rather than retreat from the space. But rather than try to bottom-fish in the most volatile and speculative names, I would focus on stable growth names, i.e., those companies with consistent earnings, high cash flow generation, and strong pricing power.

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
3.48K 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.

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