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Growth Stocks Have Been Hit Hard by Rising Rates — But Could Be Saved by a Recession
“I would expect growth to outperform over the near term as we start to price in weaker economic growth over the next year or two,” said Guidestone Capital’s David Spika.
Investment experts hold mixed views about the link between interest rates and growth stock performance. But there is one thing they generally agree on: growth stocks are good investment opportunities at the late stages of an expansionary economic cycle.
Growth stocks have dipped into bear market territory since central bankers started signaling rate hikes in December. But if the Federal Reserve becomes overly aggressive on tightening, a recession might hit the U.S. economy, prompting investors to seek out growth stocks once again. The trouble is that during a recession, good quality companies will be harder to find — and higher priced as a result of increased demand from investors, according to David Spika, president and chief investment officer of Guidestone Capital Management.
“Value stocks perform the best when the economy is expanding,” Spika explained. “Growth tends to take over when the economy turns south.”
Spika believes the Fed’s quarter point rate hike on Wednesday has already signaled that the current economic cycle has peaked — is at an “inflection point” — and there are signs of a slowdown. “Economic data starts to weaken. The market will start to anticipate a recession and slower growth,” he said. “When the economic growth starts to wane, that’s when you want to own growth stocks.”
Jim Monroe, senior consultant at Investment Metrics, a portfolio analysis and data firm, agreed that growth stocks are good bets when economic contraction looms. Although the Fed has only started hiking rates, Monroe said there will be plenty of time for people to invest in growth. “If you look towards the end of the tightening cycle, you see a lot of risk-taking and a lot of valuations getting stretched,” he said. “That’s a time where growth can definitely outperform again.”
But Monroe didn’t think the recent rate hike will lead to a sharp economic downturn. “There will be a transitional period for growth to beat value,” he said, adding that he doesn’t expect that to happen in the near term.
Not surprisingly, economists don’t all agree on whether the Fed’s tightening policy is leading the U.S. economy to a recession. John Bilton, head of global multi-asset strategy at J.P. Morgan Asset Management, said in a briefing this week that he doesn’t think “recession in 2022 as a base case” even after the Fed implied six consecutive rate hikes. “Inflation is obviously stickier, and we are concerned about how that plays out,” he said. “But bear in mind, we still see a negative real-rate environment, [which will] probably stay negative throughout this year.”
Yet Jim Reid, head of global fundamental credit strategy at Deutsche Bank, pointed out in a Wednesday note that “all hiking cycles that invert the curve have led to recessions within one to three years.” The yield curve has been running flat since March 2021 and may be inverted earlier than expected with the quarter point rate hike, according to Reid.
Longtime growth investors are tuning out rate hikes. Ankur Crawford, who oversees large-cap stock strategies at Fred Alger Management, said that short-term market volatility will not affect her judgment of long-term growth stocks. “The growth we are seeing today is generational growth,” she said, adding that opportunities in connective intelligence, artificial intelligence, Internet of Things, and the metaverse will continue to deliver promising long-term returns.
Still, Spika thinks there is an opportunity amid the changing interest rate regime. “I would expect growth to outperform over the near term as we start to price in weaker economic growth over the next year or two,” he said. “You pay up for growth when growth is scarce.” And that scarcity of growth in a contractional environment will especially appeal to growth stock investors.