Telemus Weekly Market Review January 16th - January 20th, 2023
After a turbulent year for growth stocks in 2022, how has sentiment shifted for 2023?
The Russell 1000 Growth Index is the common benchmark measuring the performance of the large-cap growth segment of the US equity universe. The index was down -29.14% compared to the Russell 1000 at -19.14% in 2022. The growth segment of the equity market is traditionally defined as companies with above average earnings growth rates that also trade at above average valuations. The underperformance of growth stocks in 2022 was a function of the Federal Reserve hiking interest rates as a measure to tame inflation, which consequently makes borrowing more expensive for companies that need cash influxes to expand their growing businesses. With more hikes forecasted in 2023, is it wise to keep existing investments in growth stocks or to add new positions?
When we’re determining exposure to growth stocks, we always try to keep a long-term lens of at least five years. With the overall stock market volatility and economic uncertainties during shorter timeframes, it’s unrealistic to try to time moving into or out of the growth segment of the market. As you can see from cumulative returns in the table below, the Russell Growth Index has underperformed the broader Index when you look at shorter time frames. However, it’s common during spans of 5-plus years that growth outperforms.
Source: Bloomberg. Data as of 12/31/22.
There has been a clear sentiment shift favoring value stocks across all market capitalizations of late, as seen in the Morningstar Equity Style box returns shown below through December 31, 2022. On top of the increase in interest rates dampening growth companies’ ability to borrow, we’re seeing increased announcements of layoffs, especially in big tech growth names, which we see as a sign that their executives know they are going to have financial challenges in the near term.
Although value has roared back, there are pockets of the growth style that we believe can still outperform. We see the most attractive part of the growth segment being companies that are migrating closer to the mature phase of their corporate life cycle. These are companies with expanding operating margins and stronger cash flow generation supporting high levels of reinvestment back into the business. These companies have market leadership, clear points of differentiation versus competitors and are still innovating. This differs than in previous years where the market favored earlier stage growth businesses, that may not have been profitable or have established markets.
We expect the storm for growth stocks to lessen in 2023. In fact, through the first three trading weeks, growth stocks have outperformed value by roughly 1%. Nonetheless, given what are still slightly stretched valuations for growth versus value (as seen in the final chart below), a more challenging backdrop for corporate fundamentals, and more favorable sentiment toward value stocks, we aren’t projecting a swift rebound for the style. However, we do believe we are entering an environment where stock selection decisions become more paramount and expect there to be several individual growth stocks that stand out, especially when viewed through a long-term lens.
Forward P/E Ratio: Russell 1000 Growth relative to Russell 1000 Value
Source: Columbia Threadneedle Investments, Bloomberg. Data as of 12/30/22
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