Weekly Investment Commentary: Finding value in growth stocks
Bottom line up top
- Tough times for growth stocks continue, but we see glimmers amid the gloom. Growth stocks suffered year-to-date losses through May five times larger than their value peers, and that slump is extending into June. The road ahead looks bumpy, but we may start to see inklings of improvement during the second half of 2022. Among the factors at play:
- Relative valuations are attractive. Price-to-earnings (P/E) multiples for growth and technology shares look potentially more inviting after major growth-oriented indexes like the Nasdaq Composite and Russell 1000 Growth Index tumbled into bear market territory. By the end of last month, Russell 1000 Growth valuations had fallen below their 5-year average (Figure 1).
- Moderation in inflation remains elusive, although a plateau may be in sight. Last week’s elevated CPI print for May and spike in the 10-year Treasury yield to a new 2022 peak made clear that the high inflation, rising rate environment that’s been hampering growth stocks has yet to abate. A rare bright spot in May’s CPI report was broad deflation in goods prices, indicating that the shift in spending toward services remains intact. Dovish observers might also point to other recent data showing decelerating wage growth, a peak in job openings and a gentle rise in unemployment claims.
- Maximum Fed hawkishness: priced in or more to come? With both CPI and PCE inflation (the Fed’s preferred barometer) still too high, we expect 50 bps rate hikes at each of the summer FOMC meetings (June, July and September), with some upside risk to 75 bps this week. While a Fed-enabled soft landing is still possible, the path to a benign economic outcome looks narrower. It’s worth noting that growth stocks may prove resilient in a mild recession.
- Not all growth stocks are on equal footing. We’re identifying compelling relative value among a narrow set of high-quality secular growth names that should benefit from long-term structural trends. We believe these are companies that are positioned to outperform in a decelerating economy, while simultaneously preparing for future growth.
“We’re currently identifying compelling relative value among a narrow set of high-quality secular growth names that should continue to benefit from long-term structural trends.”
Growth stocks are an important part of our balanced focus. Within global equities, we currently favor large cap stocks, particularly in the U.S., with a balanced focus on growth (given the slowing economy) and value (especially in the energy sector, due to favorable supply and demand dynamics). Ultimately, we are more interested in which sectors and companies have the right fundamentals in place. That perspective means not ignoring solid growth opportunities where we find them — including certain mega-cap software names whose valuations have compressed and are trading on reasonable earnings or cash flow multiples.
Investors with a high degree of confidence may want to explore select opportunities in emerging markets. After a challenging 2021 for Chinese internet stocks, we think their risk/reward profile is positively skewed today. The negative impact of COVID-19 lockdowns has given way to newly announced stimulus measures to boost economic activity and a more business-friendly regulatory environment. Against this backdrop, the CSI Global China Internet Index — which was valued at a price of over 6x revenues at its peak in 2021 and is now below 2.5x — recently broke above its 20-week moving average (Figure 2).
“Ultimately, we are less concerned about one style beating the other and more interested in which sectors and companies have the right fundamentals in place.”
We expect market volatility to persist over the near term. While our medium-term outlook remains cautiously optimistic, more wary investors might choose to emphasize dividend-growing companies with strong balance sheets that have been less affected by multiple compression relative to other U.S. stocks, especially large caps ex-energy (Figure 3).
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