Is It Finally Time for Growth Stocks to Shine Again? - 7investing 7investing
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Is It Finally Time for Growth Stocks to Shine Again?

It might seem crazy given current market volatility, but now might be the perfect time for growth stocks to shine once again.

September 26, 2022

The S&P 500 index just touched a fresh 52-week low on Monday (September 26, 2022), down more than 24% from its January peak. The tech-heavy Nasdaq Composite index has fared even worse, closing down more than 33% from its January high today. Many individual stocks have been hammered even worse in the process. I can’t deny it feels absolutely awful to be an investor in equity securities right now.

And if I didn’t know any better, it would be undeniably tempting to simply step out of the market altogether. In fact, many people have done exactly that; One in five consumers has closed an investing, trading, or brokerage account over the past year. U.S. equity funds have posted several weeks of outflows as sentiment has turned overwhelmingly bearish.

But what if — and please bear with me here — what if I told you times like these are exactly the times you should be most excited as a long-term investor?

Because as someone who’s experienced the awful feelings of a relentlessly declining portfolio several times in my investing career, that’s exactly what I’m here to reiterate: As bad as it feels right now, I’m terribly excited for what’s to come in the stock market over the next several years.

The case for growth stocks

Where should we be putting our money to work?

My vote goes to small- and mid-cap tech/growth stocks — yes, the very ones that have been absolutely hammered since peaking in late-2021. Many high-growth tech stocks have fallen 60%, 70%, and even 80% or more from those highs thanks to a combination of steep inflation, geopolitical conflict, recession and inflation concerns, rising interest rates and quantitative tightening from the now-hawkish U.S. Federal Reserve as it seeks to tame inflation. Of course, in hindsight it’s clear that many tech and growth stocks were trading at inflated valuations last year due to the Fed’s easy money policies, with low interest rates making the potential returns of riskier equity securities all that much more attractive relative to their fixed-income counterparts.

So why growth stocks now after all the recent pain? Couldn’t they continue to fall from here?

Well, sure, they very well could (keep falling). Many of these growth stocks are yet-to-be-profitable businesses still burning cash — and value of of their future cash flows becomes less valuable as interest rates rise. But for many of the highest-quality growth stocks — particularly those that are already generating positive cash flows and/or have achieved even modest bottom-line profitability, I think we’ve already seen a brief preview of growth stocks’ ability to deliver relative outperformance to both the broader indexes and value-centric groups of stocks over the past few months. In particular, note that even as the S&P 500 and Nasdaq indexes hit fresh lows, many high-growth tech stocks are still trading well above their spring lows.

But take a look back to what happened as stocks attempted to rally from those spring lows — before a slightly hotter-than-expected August Consumer Price Index report two weeks ago stoked persistent inflation concerns, effectively throwing a wrench into growth stocks’ momentum. As the market placed bets that we were about to see a significant deceleration in the CPI’s inflation metrics, small- and mid-cap growth and tech stocks (see the Russell 2000 Growth index) were leading the charge, massively outpacing the returns of large-cap and value-centric stocks in the process.

Since then, however, the market has relentlessly driven this group of stocks lower, providing what I believe will prove a fantastic opportunity for patient, long-term investors to open or add to their positions.

If I were a betting man, I’d wager that the market was simply too early in expecting inflation to rapidly cool starting with the August 2022 report two weeks ago. That most recent hot CPI reading — which showed inflation for the month of August had cooled slightly less-than-expected to 8.3% (year over year) from 8.5% in July and a 40-year high of 9.1% in June — might well prove to be the last before we truly see year-over-year inflation begin to moderate in earnest. Commodity and freight prices have since continued to fall, supply chain issues are steadily being resolved, earnings for many of the growth stocks I personally favor were exceptional by every measure, and it seems the CPI print for September (due for release on October 13, 2022) has a decent chance of actually providing the positive inflation surprise the market was hoping for earlier this month. If not, I won’t be surprised if the market begins to view subsequent reports as capable of delivering such surprises.

As such, I believe that last month’s brief, violent rally in growth stocks could prove indicative of what’s to come as our forward-looking market begins to anticipate not only further declines in inflation, but also the eventual about-face from the U.S. Federal Reserve toward a more dovish policy stance. When that happens, it could revive the rally in risk assets for the foreseeable future.

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