Will this madness ever end?
It will (it always has). Growth investors need to be ready.
To say it’s been an ugly year for growth investors would be an understatement. The Russell 3000 Growth Index is off 25% from last November’s highs, the decline in small-cap growth stocks as measured by the Russell 2000 Growth Index is even larger and certain growth industry clusters have gotten downright clobbered. Biotech and software, respectively, have plunged more than 60% and 43% from their 2021 peaks—steeper than selloffs during the 2008-09 global financial crisis/recession and the 2020 Covid crisis/recession.
And that’s the rub. As fraught as the situation is, with the Federal Reserve seeking to tighten enough to slow inflation but not too much to provoke a recession, our base case remains an economy that slows (soft landing) but avoids a protracted economic contraction (hard landing). Sure, the Fed’s walking a fine line between slowdown and recession. But with almost two job openings for every one unemployed person, with households and corporations flush with cash and their debt service manageable after having locked in generational lows in rates, and with consumers willing and able to spend after more than two years of being holed up, the Fed has a lot to work through before that fine line gets too taut and snaps.
Put another way, growth stocks arguably have been pricing in a worst-case scenario that we don’t believe will be the case. When the market comes to sense this—and the recent behavior of intermediate-to-long Treasury yields (their increases appear to be slowing/leveling off) and credit spreads (their widening appears to be slowing) indicates it may be getting near that point—we believe growth stocks could see a significant rally. Are we there yet? Who knows? But down markets don’t typically last forever.
While the past can never predict future behavior, we find it noteworthy that following their biggest market declines over the past 14 years, biotech stocks rose an average 68% and software stocks an average 40% in the year following their lows, according to widely held ETFs that track the two respective industries. Moreover, we also note that growth stocks historically tend to perform well during periods of moderate economic deceleration, buttressed by valuations that turn more favorable as rates decline, and by typically strong cash flows and underlying demand.
The bottom line: it’s hard to be patient when there’s been so much carnage. But the pain should end, possibly soon. Our recommendation is growth investors need to be ready.