Rushing Into Growth Strategy Comes At A Cost

By Michael Msika, Bloomberg Markets live reporter and strategist

This year’s competition for equity market leadership appears to have ended, with growth stocks scoring a decisive win over their value rivals.

The two equity categories jostled much of this year to take the upper hand, as investors struggled to decipher the outlook for interest rates and economic growth. No longer. Fund managers are rushing now for growth-oriented sectors such as technology, convinced of a soft landing for the US economy, with slowing inflation and falling bond yields. The result is a clear outperformance for growth strategies since the start of November, feeding a hot streak in world markets.

However, growth equities come at a cost, especially as their earnings profile has underwhelmed in recent years, relative to value. That’s left the group trading at hugely expensive valuations, with a premium of more than 60% to the overall market. And compared to value, growth is twice as pricey.

“Lower yields are good for long-duration stocks.” says Oddo strategist Thomas Zlowodzki, predicting the rally to extend if yields continue to fall. Gains are unlikely to be curbed by signs of an economic slowdown, he reckons, “as growth stocks are protective in the event of an economic slowdown, which will also weigh on yields.”

“This could last for a few more weeks, until the next central bank meetings,” he adds.

Borrowing costs have come down aggressively in the past few weeks, with US 10-year Treasury yields now at about 4.4%, having hit 16-year highs above 5% just a month ago. While inflation is still above the Federal Reserve’s 2% target, money markets wager interest rates will start falling by mid-2024.

UBS Global Wealth Management CIO Mark Haefele is among those expecting slower economic growth to feed through into rate cuts. “In our view, government bond markets are overpricing the risk that high interest rates will represent the new normal, and we expect yields to fall in 2024.” he says.

Yet the earnings picture has improved this year, with analysts starting to lift EPS forecasts for growth companies faster than for the rest of the market.

Emmanuel Cau at Barclays acknowledges that growth is expensive and value cheap, but attributes that partly to excessive rate-cut optimism. “Their relative valuation has not yet adjusted to the new higher-for-longer rates regime,” he says, predicting this will change as investors lose their fear of recession and start selling richly valued growth in favor of cheaper value. “On positioning, unsurprisingly, we have seen flows to growth and defensives year-to-date, versus value and cyclicals,” Cau adds.

Ultimately, peaking bond yields will benefit growth stocks, while improving economic growth will help value, Goldman Sachs strategist Lilia Peytavin points out. Given a likely picture of lower bond yields and above-consensus economic growth, Peytavin advises going for “pure growth” stocks — the segment that’s relatively more sensitive to economic cycles, and has therefore taken a harder knock from rising rates.  

Such a strategy would overweight technology and health care, and includes companies such as Ferrari, Hermes, Novo Nordisk, AstraZeneca, Teleperformance and Worldline, she adds.