David Jane of the Premier Miton Macro Thematic Multi Asset team, considers whether now is the time to pivot back to growth stocks
The last year has seen a huge recovery in value stocks, inflation beneficiaries in particular. At the same time growth stocks have had a torrid time. The Nasdaq is down 28% from its peak, at the time of writing (Source: Bloomberg as at 11.05.2022), and commentators are beginning to draw comparisons to the bursting of the tech bubble back in 2000.
The obvious near-term cause of the tech collapse has been the rise in inflation and consequence rises in short- and long-term interest rates. Just as falling rates drove the growth stock bull market of the last ten years, rising rates have led to its demise.
Multi asset funds that have a growth style bias have started to underperform, while those more focussed on value (including those with a UK bias) have done best. This causes a dilemma for fund selectors who have backed the best performing funds of recent years: whether to switch into value or stick with the holdings that have served them well. We think the answer is neither, clients should blend.
In our funds, we mix macro views with long-term themes. Macro views tend to be relatively short term, as the macro environment changes continuously. Although there is generally an over-arching macro paradigm, such as lower for longer during the post GFC bull market. Post Covid we feel the environment is rising rates and rising inflation for a potentially extended period. At present, our macro views have a value bias, value does relatively well in rising rates and higher inflation. Growth tends to do well in an environment favouring long duration assets.
The thematic side of our portfolios focusses on the long-term growth themes that drive the global economy. These generally fall into technological changes and demographic developments. Such investments can often have a growth bias, although not in all cases.
At present, we are positioned for economic uncertainty, combined with the long-term belief that inflation will be higher than the consensus over the coming years. We would like to balance this with more of our themes, but their growth bias means we have a reduced exposure currently. For this reason, the question of when growth might, at least, cease to underperform is important to us.
Drivers favouring growth
Two things might drive a return to performance of the growth orientated parts of the market. One would be a change in the market environment, such as a positive outlook for bonds and falling inflation expectations. The other is growth stocks in general getting back to attractive valuations.
We think the inflationary environment may peak short term at some point this year but that the structural background is one where inflation is structurally much higher than before. Any rally driven by a bond rally is likely to be temporary.
However, the other factor is more important. At the right valuation, growth stocks can outperform in any market environment. The reason is simple, if they have real growth that can offset any decline in valuation driven by the macro environment, the key is paying the right price to start with.
Therefore, we think a major consideration for any increase in our growth exposure will be valuation. At present, while prices have come down significantly, for many smaller companies in particular, large cap growth stocks still do not appear to be cheap, at least to us.
The market has to start to be more realistic about cash generation and in particular, where that cash goes.
Take Meta (owner of Facebook), as an example. Over the past 5 years it has spent $88bn buying back shares equivalent to nearly 20% of its market value at the start, yet its share count is barely changed, share options to management have replaced those shares bought in. That $88bn is the vast bulk of reported profits and cash flow over the period. In simple terms, around $90bn has been transferred from shareholders to staff and management.
Conversely, shareholders in Exxon Mobil have received $71bn in dividends over the same period and their share count remains the same. The vast bulk of its value generation has gone to shareholders rather than management, yet its market value remains only 60% that of Meta.
In conclusion, increasing exposure to our growth themes will require more discernment than was necessary during the growth bull market. The easy times are over, we are in a rising rate and inflation environment. That is not to say that some growth stocks won’t be amongst the best performers in coming years, genuine growth stocks can always perform well. However, many of the past winners will turn out to have been illusions created by cheap money. Over time, we would expect the growth themes in our portfolio to increase, but for now we remain very selective.
This article was first published in the June 2022 issue of Professional Paraplanner.
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