FEBRUARY 2022 – ISSUE 1
Why growth stocks still have plenty of life
Growth versus value stocks. It’s a time-worn conundrum for investors. During the past two decades, as central governments tamed inflation, growth stocks have outperformed value stocks, notwithstanding occasional periods of under-performance.
Investors are experiencing one such period now. The trend is towards value stocks.
But that doesn’t mean value investing is the best long term option. There is too much noise and volatility to claim the multi-decade dis-inflation cycle is over, and that the more recent rotation towards value stocks will last much longer.
And that has implications for the current earnings season in Australia.
“Investors need to keep things in perspective. Everyone is talking about value stocks, but high inflation and higher interest rates are not foregone conclusions.
Many investors are preparing for a world that operates with these characteristics, but that means they could be dismissing growth stocks prematurely,” he says.
Patkar says the rotation from growth to value has been occurring since September 2020.
“It’s occurred in waves – November 2020, February 2021, September 2021 and more intensely in January this year. But we are now 16 months into the shift.”
Historically these rotations have lasted somewhere between nine and 18 months, Patkar says. In 2016 when the last significant growth to value rotation occurred, it lasted only 12 months.
“That happened when Donald Trump got elected. China was coming out of a slump in 2015 and Beijing was stimulating the economy. There was a big cyclical recovery and that’s what we are seeing this time, but on steroids because of the pandemic.
We’ve seen this before and it will happen again. That’s the perspective investors need to bring into their decisions,” Patkar says.
The trigger for the current rotation is higher inflation which has shocked the system both on the supply side, via disruptions to supply chains, and the demand side, where stimulus payments alongside changed consumption patterns has pushed up goods prices. At the same time, government restrictions have restricted many services, such as eating out or travel.
“There is no reason to believe that this will continue once things get back to normal. People will stop buying another flat screen TV and start eating in restaurants and travel again,” Patkar says.
Bond markets – a more reliable indicator of future interest rates than equity markets – support Patkar’s argument.
Inflation hawks say the consumer price index in the US will fall from its current 7 per cent level but remain above the central bank’s two to three per cent target, triggering several rate rises and eventually a sell-off in the bond market. Similarly equity markets in January sold off growth stocks, and rotated into value stocks.
“Markets are noisy and confusing at the moment. It’s important to cut through the noise,” says Prasad Patkar
Head of Qualitative Investments at
Platypus Asset Management.
“But bond market indicators today aren’t supporting the narrative of the inflation hawks,” Patkar says. “Five year forward Inflation expectations are at 2 per cent and the yield curve has flattened 90 basis points off its recent high.
So, we think that the jury is still out on the risk of inflation becoming entrenched and in turn affecting the structure of the market,” he says.
“In the short term, markets will remain volatile as the US Federal Reserve tightens and the inflation prints remain elevated. But we should see some clarity on inflation as the logistical and supply chain challenges ease in the second half of 2022,” he says.
Patkar adds the economic environment will return to pre-COVID settings.
“There are some changes from the pre-COVID world that are likely to provide a stronger inflation impulse like lifts in minimum wages, peak globalisation and energy transition,” he argues.
“But it remains to be seen if these drivers reverse the structural drivers of dis-inflation that have been present in the past 30 years.
Hopefully there are no other COVID variants that further delay this normalisation process,” he says.
The noise and volatility will make the current earnings season on the Australian Securities Exchange particularly interesting.
“Valuation risk is high in the market,” says Jelena Stevanovic, Portfolio Manager at Platypus. “There isn’t much tolerance for earnings risk. There is very little room for disappointment.”
“And investors will want to see companies able to pass on cost inflation to the end customers. Companies need to have pricing power,” she says.
“Robust demand for products is a non-negotiable, this earnings season,” Patkar adds.
Stevanovic and Patkar agree companies making excuses for performance will be a red flag for investors.
“Blaming COVID for a terrible half or blaming the weather. Those sorts of excuses will be very negative for companies.”
Author: Sean Aylmer
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