Just over seven months into the year, one issue advisors are perhaps discussing more than they anticipated at the start of 2021 is when growth stocks will return to form.
That's understandable because growth spent more than a decade really taking it to value and if an advisor happens to have a younger, more risk-tolerant clientele, growth stocks aren't just a style rotation for them. Growth investing is practically a way of life.
The other thing advisors may be growing weary of is explaining why growth is waning this year with much of that scenario attributable to rise in 10-year Treasury yields that commenced in late 2020, lasting into the first quarter.
Still, it's good teachable moment with clients as growth's inverse relationship with Treasury yields isn't something widely discussed outside of financial circles. For clients needing further confirmation of this inverse relationship, simply tell them that for the three months ending Aug. 3, 10-year yields plunged nearly 28% while the S&P 500 Growth Index jumped 11.46%.
For Now, Good Times for Growth
With Treasury yields declining, the case for growth has support and that theme isn't limited to mega-cap growth.
“The Russell 1000 Growth Index surged 11.9% in Q2, more than double the 5.2% gain of the Russell 1000 Value Index, significantly diminishing the latter’s lead for the year so far,” according to FTSE Russell. “Small-cap growth’s performance paled in comparison. Russell 2000 Growth rose 3.9% in Q2, lagging Russell 2000 Value by 70 basis points. This was a sharp U-turn from trends earlier in the year, though Russell 2000 Value remains firmly ahead of all Russell style indexes YTD and for the prior 12 months.”
The good news for growth is that earnings growth is likely to be there to support the loftier multiples. However, what's interesting about U.S. earnings growth is that value is likely to have more of it, which is probably attributable to a lower base.
“Consensus 12-month forward EPS estimates for both Russell 1000 Growth and Value have recovered strongly from their 2020 lows and are now at new five-year highs,” notes FTSE Russell. “Though the rebound has been keener for the large-cap value index, reflecting base effects from last year’s collapse, Russell 1000 Growth has seen the bigger surge beyond pre-pandemic levels. Consensus now projects 12-month forward EPS growth of 10% for Russell 1000 Growth and of 12% for Russell 1000 Value.”
Waiting on Deflation
Well, maybe not necessarily a case of full-on deflation, but if inflation proves transitory, that could be the next macro catalyst for growth stocks.
The cyclical value trade that was so hot earlier this year, while a thorn in the side of growth, likely staved off another tech bubble and extended the newest bull market. However, it gave way to inflation, which is usually a drag on growth.
“This rotation has broadened and strengthened the bull market significantly, preventing another tech and telecom bubble and setting the stage for another leg up in innovation-based strategies,” says ARK Invest CEO and CIO Cathie Wood. “Had the equity market continued to narrow toward innovation, the odds of a bust like that after the tech and telecom bubble would have increased.”
Of course, the best of both worlds scenario for growth will be no dramatic increases by 10-year yields for the remainder of the year and evidence inflation is easing. It remains to be seen if the market will oblige.
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