Growth Stocks: Have They Bottomed?

Growth Stocks: Have They Bottomed?

In a piece for Morningstar, John Rekenthaler writes that 2022 has “been a terrible year for growth stocks” and that after an initial free-fall at the beginning of the year followed by a temporary respite growth stocks are now dropping again. In April the Nasdaq had its steepest slide since 2008 but overall, 2022 has been the worst year for growth stocks since 1932.

Though the Morningstar US Value Index has only dipped slightly, the Morningstar US Growth Index has tumbled 25.9%. But has the growth stock decline run its course? Many growth-stock investors think it has: Cathie Wood purported that her ARK Innovation ETF was a “deep value” investment after being battered in late 2021 and into this year. Since that pronouncement, her fund has slumped an additional 45%—a “very deep value investment” indeed, writes Rekenthaler.

There are two circumstances in which growth stocks can rebound, the article contends. First, the economy needs to change, because the current situation is not friendly to growth stocks. Interest rates need to remain low in order for growth stocks to thrive, as they are purchased for their future earnings. And while many analysts predict that the Fed’s rate hikes will slow the economy, most believe there will not be a recession this year. Growth stocks do better when a recession looms large, so Wall Street needs to become a bit more pessimistic in order for them to rebound.

The second circumstance growth stocks need to pick up is if they become so cheap that they don’t need an ideal economy in order to rebound. Relying on this strategy is incredibly tricky; “One needs to know not only the amount of future corporate earnings, over many years, but also their volatility, as well as the level of interest rates,” Rekenthaler writes. However, Morningstar compared December 2000 and April 2022 P/E ratios for both the growth and value indexes, as growth stocks were also in a similar rut back then. That comparison shows that, if growth stocks follow a similar trajectory as they did 22 year ago, this is the midpoint of their slump and the bottom is yet to come.

While it’s possible growth could still rally this year, Rekenthaler concludes the article with the view that their rebound won’t come soon, given that the Fed seems determined to continue their interest-rate hikes, the shadow of a recession isn’t dark enough yet, and the prices of growth stocks are yet to become a bargain.