Growth stocks are showing signs that they could be coming off the mat, after a year in which they have taken a pounding, according to Gerrit Smit, manager of Stonehage Fleming Global Best Ideas Equity fund.
High inflation and rising interest rates have limited companies’ growth prospects this year, with many investors seeking cheaper opportunities in value assets.
Growth investors have been the worst hit by the volatile market conditions of 2022, but a change in in real rates could boost growth assets back into vogue.
Smit pointed out that real rates remained high for several years after the tech bubble burst and value investing outperformed between 2001-2007 as a result.
However, real rates are deep in negative territory at the moment, which could be an advantageous environment for growth stocks to outperform.
Source: Stonehage Fleming
Interest rates in the UK are currently set at 3%, but the real rate is adjusted to remove the effects of inflation. The Bank of England (BoE) expects inflation to peak at 11% in October, but Smit said that it will take a long time for real rates to return to a positive level, even if inflation is on the way down.
“As inflation drops, that may change but it is likely to take quite a while before it goes back into high positive levels,” he added. “That’s a situation which, I would argue, favours the growth style of investing.”
Indeed, continuing economic weakness or a recession could actually prove more beneficial to growth stocks than their value counterparts, Smit argued.
“During times of low economic growth or even a recession, growth becomes more difficult to achieve on a sustainable basis,” he said.
"The result is that companies that continue to grow during a downturn outperform value as investors are then more willing to pay more for it on a relative basis.”
In the past three recessions, for example, growth stocks have outperformed by 20 percentage points on average, according to Smit.
“Should that happen again – and odds for a recession are growing – growth managers may catch up materially,” he added.
Source: Stonehage Fleming
However, earlier this year Joyce Weng, manager in the emerging markets and Asia Pacific (EMAP) equities team at JP Morgan, argued that the underperformance of value stocks since 2007 is “an anomaly in an otherwise long history of value dominance”.
She added that the sizable difference in performance between value and growth indices over recent years is notable, stating: “Wide valuation spreads and low positioning indicates the potential for value to outperform is significant.”
Relative valuation of MSCI World Value vs. MSCI World Growth
Source: JP Morgan Asset Management
Rather than anticipating a resurgence in growth investing, Weng expects the opposite – she said that we “may just be the start of a value comeback” after 13 years of underperformance.
Weng has noticed many parallels between now and the 1990s, in which value outperformed by 90 percentage points over seven years after the dot com bubble burst.
She said: “We are in for a reckoning that has only just begun. Value had been out of fashion for so long that many investors have never experienced a value-led market for any significant period of time and are accustomed to short rallies lasting only six to nine months.”