Turnaround for growth stocks? What speaks for value

by Michael Herzum, guest author of Euro am Sonntag

Dhe start of the year was difficult for high-growth US stocks such as Alphabet, Netflix and Tesla. Their courses fell significantly, while industrial and energy groups as well as financial service providers were able to escape the downward trend. The reason for this rotation between growth and value stocks? The strong growth of the US economy, which has long since left the pre-crisis level behind, and increased inflation. This prompted the US Federal Reserve (Fed) to initiate monetary policy normalization faster and more decisively than originally planned.

For stock investors, this rotation is a cue to act on. In the broad US stock market indices, growth stocks have gained significantly more weight due to their extraordinary performance in recent years. Her ratings kept rising. This development took place against the background of a kind of secular stagnation, i.e. years of weak economic growth with declining inflation and falling interest rates. The period after the financial market crisis in 2008 was particularly affected by this.

The end of chronically low inflation

The corona pandemic has accelerated trends that are helping the global economy to leave weak growth and chronically low inflation behind. Accelerating technological change and more investment-friendly economic policies in the US and Europe are accelerating growth and supporting more “normal” inflation rates at or slightly above 2 percent over the next five to ten years.

As a result, this means higher nominal economic growth and, structurally, higher interest rates again. The generally expected first rate hike by the US Fed in March is not just the start of a new rate hike cycle. It is also the beginning of a journey towards higher “normal” interest rate levels.

All of this creates headwinds for growth stocks. For growth stocks, valuation anticipates much future earnings growth. If interest rates rise, future profits are already worth less today. This weighs on the prices of growth stocks on the stock exchanges. But there is a second factor that is causing the turmoil in growth stocks. For a long time after the financial market crisis, investors were willing to pay a premium for more growth in an environment of low growth. If, however, there is structurally higher nominal economic growth again, as we expect, more companies will manage to grow adequately. The scarcity of the growth factor is thus diminishing, making a valuation premium less justified. Growth stocks have also been on par with stocks from the technology sector in recent years. With the increasing digital penetration of other industries, however, this unique selling point is becoming blurred.

We therefore assume that the long-standing growth dominance on the stock markets is coming to an end. But it’s not the complete turnaround yet. Investors should not prematurely write off growth stocks, as their business models and earnings prospects are still very good in general. In addition, there are also negative factors for the value companies that are currently in particularly high demand. For example, financial companies are feeling the increasing competition from fintechs, i.e. young companies that use technology-based systems to offer specialized and particularly customer-oriented financial services.

The end of growth stock dominance

Instead of further growth dominance, there is currently more evidence for a more uniform performance of value and growth in the new post-corona macro regime. Investors should fare better by maintaining a more balanced allocation of growth and value stocks over the coming years. We therefore recommend reducing overweights in growth stocks and the United States and giving more consideration to value stocks and in particular Europe’s stock markets as a region with a high proportion of value stocks. In terms of sectors, banks and companies from the basic goods sector are likely to benefit from the rise in interest rates and from the increasing investment dynamics.

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Image sources: Carsten Lerp/Union Invest, Number1411 / Shutterstock.com