Select segments of growth still providing steady returns

Key takeaways:

• Following last year’s plunge across markets, technology and growth stocks are back on top
• Aside from a brief wobble in February, year-to-date growth has crushed every other investment style

Following the YTD strength in equity markets, Russ Koesterich discusses how a combination of cyclicals, and a growth bias may serve investors well in today’s market.

Following last year’s plunge across markets, technology and growth stocks are back on top. Aside from a brief wobble in February, year-to-date growth has crushed every other investment style. But while growth continues to advance, since early June there has been a subtle shift in market leadership. Tech is now narrowly underperforming with the top performing sectors being mostly cyclical.

The shift in leadership has occurred against a backdrop of both higher interest rates and an improving economic outlook. In this environment, investors are increasingly favoring cyclical expressions, i.e., companies that stand to benefit from economic resilience. My take is to combine the two themes – cyclicals and a growth bias – and maintain a tilt towards reasonably valued growth names, otherwise known as GARP.

Back In early February I suggested a tilt towards GARP. Despite growth dominating equity performance in the spring, cyclicals and GARP have been outperforming since early June. Not only has it beaten growth, but also the broader market and other investment styles, notably value and momentum.

Valuation and economic resilience

Part of the reason for the relative slip in growth’s performance is valuation. The style’s outperformance has been driven by relentless multiple expansion. In other words, tech and tech-related names have soared on higher valuations. In fact, soaring tech valuations have fed through to the broader U.S. equity market. The 20% gain in U.S. equities has been overwhelmingly driven by higher multiples rather than soaring earnings (see Chart 1). As a result, the technology sector now trades at some of the steepest valuations of the past 30 years.

S&P 500 sources of total return

That said, the interesting thing about today’s market is that outside of tech, most other sectors are trading below their long-term median valuation. One advantage of the GARP tilt is that it provides broader exposure to different, cheaper parts of the market.

Outside of valuation, GARP offers the potential for exposure to names geared to economic resiliency. As the economy improves – a Bloomberg survey of economists saw 2023 consensus U.S. gross domestic product (GDP) rise from 0.3% in January to 1.5% today – cyclical exposure is likely to be rewarded. The S&P 500 GARP Index evidences a higher weighting to cyclical industries such as energy, chemicals, transport, and home builders. These are all parts of the market likely to benefit from improving economic prospects.

GARP and ‘Value with a Pulse’

 Another way to identify GARP like names is to look for value stocks with a catalyst. My colleague Randy Berkowitz refers to this approach as ‘value with a pulse’. This involves identifying companies that are not only cheap relative to peers but also have evidence improving fundamentals, such as improving earnings expectations.

While I still like growth names long-term, the magnitude of the recent run-up suggests adding other investment styles as well. GARP displays an attractive mix of reasonable valuations and leverage to a remarkably resilient economy.

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