Wall Street Week Ahead: Beaten-down growth stocks alluring as Fed slows US economy

NEW YORK: Some investors are looking for bargains in beaten-down growth and tech stocks, betting they will shine as the Federal Reserve fights to slow the US economy and tame red-hot inflation.

Growth stocks – which have trounced their valued-focused peers over the last decade – have borne the brunt of the Federal Reserve’s hawkish turn this year, with the Russell 1000 Growth index down more than 11% year-to-date, compared to a more-than 5% loss for the benchmark S&P 500 index.

By contrast, value stocks – often defined as shares of economically sensitive companies trading at a discount to their total worth – are broadly flat on the year.

Underpinning those moves is the perception that the Fed’s fight against inflation will keep interest rates climbing, eroding the future cash flows that growth stocks are heavily valued on. Value stocks, meanwhile, have found support from a strong economy and surging commodity prices.

That dynamic could change if the Fed’s tightening monetary policy slows the economy. That would boost the appeal of growth names for some investors who believe their profits rely less on broader economic strength. The Fed raised interest rates by 25 basis points last month and has hinted at meatier increases ahead.

Expectations of an aggressive Fed briefly turned the spread between yields on two and 10-year Treasuries negative last week, a phenomenon that is often seen as an indication of worries about economic growth. Recessions have followed six of the last seven yield curve inversions since 1978, according to data from Truist Advisory Services.

“If these recession fears grow, then you are going to have a big shift away from value stocks,” said Esty Dwek, chief investment officer at FlowBank, who has been increasing her stake in technology stocks. “Sustainable earnings growth … will become more important again.” Growth stocks have tended to outperform in the six months following yield curve inversions, with the Russell 1000 Growth Index rising by an average of 6.4% during such periods since 1978, compared to a 4.4 % gain for value stocks, data from CFRA showed. Growth stocks have fallen by an average of 0.6% during recessions, while value stocks have fallen by an average 6.8%, according to CFRA data.

The Russell 1000 Growth Index is up 320% over the last 10 years, compared to an 145% rise for its value-focused counterpart.

Earnings season kicks off next week, giving investors a closer look at how companies have fared at a time of heightened geopolitical uncertainty and rising commodity prices. Also on tap is the latest US consumer prices report, due out on Tuesday. The S&P 500 is on track to close down 1% this week, as worries over a more aggressive Fed slow a rally that saw the index pare its year-to-date losses last month.

Overall, investors have sent a net $4.2 billion to the Invesco QQQ Trust - which tracks the growth-heavy Nasdaq 100 Index - over the last three weeks, the fund’s longest streak of positive inflows since January, Lipper data showed.

Mayukh Poddar, a portfolio manager of Altfest Personal Wealth Management, has increased exposure to growth stocks in healthcare such as Boston Scientific and mega-cap tech names like Microsoft in anticipation that the Fed’s hawkish tilt will slow the economy, hurting value stocks.

“The Fed is telling us ... that fighting inflation has become their priority and the only way they can fight that is to slow down demand,” he said.

Some on Wall Street are skeptical of a bounce in growth stocks, especially as bond yields continue soaring. Yields on the US benchmark 10-year Treasury recently hit 2.71%, their highest level since 2019.

“The period of extremely low interest rates was very good for growth stocks and very challenging for value investors,” wrote Tony DeSpirito, chief investment officer, US Fundamental Equities at Blackrock, in a recent note. “The road ahead is likely to be different, restoring some of the appeal of a value strategy.” Others believe it is just a matter of picking the right stocks.

Moustapha Mounah, an assistant portfolio manager with James Investment, has cut his energy stock exposure to 8% of his portfolio from 12%, while moving into software companies such as Abobe and SalesForce that he expects will be able to raise prices amid continued high inflation.

“The growth stocks that are really getting hurt are the speculative names, but there are many companies out there that will do well regardless of the cycle in the economy,” he said.