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This article first appeared in the Financial Times
INVESTORS reeling from turbulence in stock markets may be glad to see the end of a very wobbly January. But questions continue to come at them thick and fast - chiefly over the outlook for the US. Will it power ahead in 2022? And how vulnerable to changing conditions are the star companies beloved of “growth” investors?
It has been wrong to bet against the US stock market for many years and last year was no exception. Wall Street delivered a total return, including dividend income, of around 30%. Please remember past performance is not a reliable indicator of future returns.
But Nasdaq, the tech-heavy index, is now officially in correction territory, falling more than 10% since the latest peak in November. With more than 220 US-listed companies with a market cap of $10bn-plus down at least 20% from their peaks, it appears the threat of inflation is beginning to bite, as well as the US Federal Reserve opening the door to rate rises and accelerating the tapering of bond purchases.
The stellar performance of the US in recent years has largely reflected the superior earnings performance of its companies. Profits outperformed expectations in the first three quarters of 2021 as vaccines were rolled out, while the country’s dominant tech sector proved itself a winner in all market conditions.
This year, though, many of the often-unprofitable technology growth stocks favoured by investors like Cathie Wood of the Ark Invest exchange-traded fund, have been shunned by investors, in favour of steadier “old economy” equities, the latter regarded as a hallmark of Warren Buffett’s investment style.
Buffett is considered the world’s greatest value investor while Wood has been dubbed the “Queen of the bull market” and a champion of growth investing. The reversal in relative performance between the two is being hailed by some as evidence of a broader switch from growth investing towards value-style investing - a long-overdue “market regime change”.
An improving economic outlook marked by strong US employment numbers and a belief that the Fed will soon raise interest rates are the main drivers for investors moving out of those rapidly expanding businesses that may not always be profitable (growth companies) to more price-sensitive, beaten-up stocks (value).
Readers should bear in mind that while stock markets are skittish, this is far from the first correction since the pandemic struck - in Nasdaq’s case it is the fourth. US shares are more expensive than any others, but there is still a lot to be said for the defensive qualities of the big tech stocks that account for nearly a quarter of the value of the S&P 500. Nonetheless their high valuations owe a good deal to low interest rates, which look vulnerable to the Fed’s harder stance on inflation.
Many investors are selling their winners and buying the laggards – a well-rehearsed playbook at market inflection points. As one fund manager put it: “We’re in a world of erratic returns where factor and style shifts blaze up quickly and then burn themselves out seemingly without explanation. It’s the sort of bull market that gives you grey hair as we hit so many inflection points in stock market trends.”
There’s little disputing that investor sentiment has become more fragile in turbulent economic, monetary policy and political conditions. Stocks leading the market are changing places at an unusually fast pace. Investors are churning between reflation, stagflation and resilient growth stocks, with alarming inconsistency.
But there’s no disputing that the dominance of growth strategies is starting to wane. As central banks have shifted interest rate policy to tackle inflation, resilient, long duration growth assets have sold off sharply and investors have switched into oil and gas, mining and financials – areas of the market that may benefit from a sharp earnings recovery.
“What it means is that we’re getting back to an investing world that isn’t so binary any more. We started to see this shift last year,” explains James Thomson of the Rathbone Global Opportunities Fund, a UK fund that has benefited greatly from its exposure to tech stocks and a pro-growth investment style.
Thomson believes the best way for individual investors to manage this shift is to ensure they have balance in their portfolio. He reduced his fund’s tech position from 29% down to 20% a year ago by selling the “work from home” stocks that shot out the lights in the early days of the pandemic.
Instead he moved into banks and “picks and shovels” old-economy stocks - the kind of industrial companies such as Sandvik and Deere, which do well at times of higher demand.
He also added some names in retail, luxury goods, transport and other consumer plays like delivery and logistics companies Hermes and JB Hunt, and retailers TKMaxx and Costco, which benefit from a reopening economy and the end of what he dubs the “socialising recession”.
A better balance between the two investment styles of growth and value seems sensible. But a modest retreat from “peak growth” does not mean that value is now the only game in town. The US is the most important stock market in the world and it’s where growth is still to be found. Profits at US companies are growing four times faster than those in the rest of the developed world - and many of these companies have competitive advantages that are hard to duplicate or catchup with. It makes little sense to expunge Wall Street from a portfolio - even if tightening policy and high valuations argue for an element of caution.
Growth stocks have outperformed value, almost without challenge, for the past 15 years - so a period of catch-up should come as no surprise to investors. Scoop up some value opportunities but be wary of “value-washing” your portfolio - and leave room for the argument that pure growth strategies will continue to thrive in a world where there is still a scarcity of widespread growth.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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