Perspectives | Growth Speeds Through A Yellow Light

August 2019

Growth and Everyone Else

Investor demand for growth-oriented equity investments continues virtually unabated in 2019. And why wouldn’t it? You invest to benefit from the potential growth in dividends and cashflow from a company. A preference to bet on the future potential, compared with the known dividend and cashflow of value-oriented companies, continues to increase the gap between U.S. growth and value siblings. For the past 12 months through July, the Russell 3000 Growth Index’s 9.9% gain doubled-up Value’s 4.2% rise. Small caps have struggled but still show a sizeable gap (Growth -1.2% / Value -7.7%). Mid caps are almost laughable: mid-growth stocks have gained 14% vs. just 2% for value.

Danger Will Robinson, Danger

Keep in mind ― we’re a long way away from the Financial Crisis where newfound optimism around market and corporate improvement began to take steam. March 2019 marked a decade of the market generally going straight up with below-average volatility. But, there are certainly warning signs starting to flash yellow.

Globally, industrialized countries are in non-expansion mode. Among the G7 (Canada, France, Germany, Italy, Japan, United Kingdom, and the U.S.), only Canada and the U.S. are above the key 50 measure for PMI (Purchasing Managers’ Index, 0 to 100 scale) that indicate a country is in expansion mode. China is also below the key 50 mark. Earnings have also not kept pace with the increase in stock prices this year, especially in the large cap space. The price/earnings ratio of the Russell 1000 Index has increased 21% this year, indicating that investors have been strongly bidding up stock prices on future hope. The amount of global debt trading with a negative yield (meaning governments are essentially getting paid by people to borrow money) is about $15 trillion, or 25% of global debt outstanding, an amount that has nearly tripled since October 2018. Finally, the 3-month and 10-year yield curves have crossed this year, meaning that short-term interest rates are higher than long-term rates, a scenario that historically signaled a coming recession, though timing has varied. Here, it has been more that investors are plowing money into longer-term, safe-haven bonds (bond prices and yields have an inverse relationship) rather than shorter-term rates rising due to inflation.

Move Aside and Let Growth Go Through

Despite the warning signs, growth has pushed forward. In addition to the total return gains, the perceived benefits of value-oriented stocks have not been a safe haven during recent volatility. Growth stocks have outperformed their value counterparts during the declines seen in December 2018, May 2019, and in the first few weeks of August this year as rhetoric around the U.S.-China trade-war intensified.

The "Uncle" Scenarios

There are a few scenarios that could slow the growth party. First is an increase in inflation. Inflation has been so low for so long it has lulled the market into a false sense of security thanks to the government’s activity in rate and monetary policy changes. The reality of any long-term trade war implications materializing in the economy will also be a headwind. The market appears to be priced for perfection right now, as any mention or hint of disruption in trade, growth, or interest rate changes send investors into a heated frenzy. The market finally capitulating to valuation multiples is also a material concern. If earnings growth does not reignite, at some point investors will pause, causing a decline in valuations. Obviously, there is no guarantee of when, if, or how the market may roll over. But given the length of the current rally and the state of the economy, we encourage investors and clients to examine their overall exposures and rebalance criteria and make any necessary adjustments.

Printable version

 
 
Sources: 
Index return data and valuations from Morningstar
Purchasing Managers Index (PMI) data from IHS Markit Group
Global debt information from Deutsche Bank
 
Important Information:
The Russell 3000 Growth Index is a broadly diversified index predominantly made up of growth stocks in the United States.
The Russell 3000 Value Index is a market-cap weighted equity index based on the stocks in the Russell 3000 Index with lower price-to-book ratios and lower expected growth rates.
The Russell Midcap Growth Index measures the performance of the mid capitalization growth sector of the U.S. equity market.
The Russell Midcap Value Index measures the performance of the mid capitalization value sector of the U.S. equity market.
The Russell 2000 Growth Index measures the performance of the small-cap growth segment of the U.S. equity universe.
The Russell 2000 Value Index measures the performance of the small-cap value segment of the U.S. equity universe.
The Russell 1000 Index tracks the highest-ranking 1,000 stocks in the Russell 3000 Index.
The Purchasing Managers Index (PMI) is measure of the prevailing direction of economic trends in manufacturing.
The indicies are unmanaged and does not incur management fees, transaction costs or other expenses associated with investable products. It is not possible to directly invest in an index. 
Past performance is not indicative of future results. The views expressed above are as of the date given, may change as market or other conditions change, and may differ from views express by other MF associates. This is not a solicitation to buy or sell the securities mentioned. Do not use this information as the sole basis for investment decisions, it is not intended as advice designed to meet the particular needs of an individual investor.
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