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Growth Stocks Are Rebounding – At Least For Now

High-quality companies are expected to do well in an environment in which investors are looking for “cautious growth,” according to Investment Metrics.

Growth stocks appear to be taking the upper hand, again.

Value managers had a spectacular go of it during the first two months of 2022. In January, value subfactors outperformed the U.S. market by an average of nearly 3 percent, according to data from Investment Metrics. By February, some value subfactors such as earnings yield and sales-to-price continued to deliver outsized returns. 

But that upward trend for value stocks suffered a sharp reversal last month. According to IM’s latest factor performance report, all but one value subfactor failed to beat the benchmark, while all growth subfactors outran the market by at least 50 basis points. Stocks with good historical earnings and sales growth outperformed the U.S. market by 140 basis points and 130 basis points, respectively, according to the report.

And the U.S. wasn’t the only place where growth outperformed value last month. In Europe, growth subfactors measured by dividend, earnings, and sales beat the market average by at least 40 basis points. Most value subfactors, on the other hand, lagged their respective benchmarks. 

Some managers had already begun to sense a growth comeback in late March. Los Angeles Capital Management, for example, found that investor preferences had been shifting from value to growth since the last week of March. Part of that was due to the fact that investors had grown more accustomed to global macroeconomic volatility and were ready to move away a bit from defensive strategies. 

Jim Monroe, senior consultant at Investment Metrics, said that there’s a common belief that value would beat growth in an environment of high inflation and rising interest rates. “But that’s not always the case,” he said. “We are in an uncertain macroeconomic environment. [As] we get to what we call a late cycle and approach recession, I would expect to see a shift back into quality, back into growth, and away from value,” he added.

But Monroe said that it’s still too early to predict which factor will outrun the other for the rest of the year. “With the changes in fundamentals from the Ukraine war and the knock-on effects on the supply chain, it’s kind of a period of uncertainty,” he said. “And I don’t think we are in an environment where it’s clear [that] either value or growth is going to dominate. I think we need a little more stability and predictability in markets for that to happen.” 

According to the IM report, quality and momentum also outperformed in March. Quality subfactors such as return on equity, net profit margin, and sales growth stability delivered an average outsized return of nearly 40 basis points. Two of the three momentum subfactors beat the benchmark by at least 100 basis points.

Monroe said that high-quality growth companies, which have demonstrated high profitability and are less speculative than those with unstable cash flows, are doing especially well. “It’s like a lower-risk version of growth,” he said, adding that such high-quality growth stocks were overshadowed by the low-quality variety in 2020 and 2021. But as investors look for more “cautious growth” this year, these companies are expected to deliver higher returns. 

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