Completely neglected in mid-June, growth stocks rebounded thanks to the decline in interest rates. But if the prospects seem rather favorable, selectivity remains in order.
On June 15, 2022, the US Federal Reserve (Fed) announced that it would raise its key rate by 0.75%, the largest increase since 1994. The next day, a series of mixed economic indicators heightened investors’ fears. As a result, stock markets plunge and technology stocks tumble. The Nasdaq index closed at 10,646 points on June 16, down 34% from its peak in November.
On June 15, 2022, the US Federal Reserve (Fed) announced that it would raise its key rate by 0.75%, the largest increase since 1994. The next day, a series of mixed economic indicators heightened investors’ fears. As a result, stock markets plunge and technology stocks tumble. The Nasdaq index closed at 10,646 points on June 16, down 34% from its peak in November. Seven weeks later, the situation has completely changed. The Nasdaq is even close to formalizing its entry into a new bull market by crossing the 20% gain mark since its June 16 closing low. This will be the case if the Nasdaq closes a session at more than 12,775.32 points. However, the company results announced since the beginning of July remain mixed. Within the US S&P 500 index, 6 out of 10 companies unveiled results above the consensus of analysts, a proportion lower than the historical average (77%) despite unambitious expectations. In Europe (Stoxx Europe 600 index), just over 6 out of 10 companies have beaten consensus so far, but earnings growth is limited outside of energy and commodities. Profits in the technology sector only rose by 1.8%. The main reason for the rebound in technology stocks is rather to be found in the bond markets and long-term rates in particular. Valuations of growth companies are more sensitive to interest rates since earnings in the distant future must be discounted. The discount rate used to do this depends in particular on the reference rates on the bond markets. The higher the latter, the lower the present value of future benefits. This also explains the very strong correction of the Nasdaq at the start of the year, when rates were rising. But since mid-June, long-term rates have been falling. The yield on the 10-year US Treasury note, a true global benchmark, has fallen from a peak of 3.5% in mid-June to less than 2.7% at the time of writing. rates may be intriguing as inflation continues to flirt with 40-year highs in both Europe and the United States and as Western central banks raise their key rates one after the other. The European Central Bank (ECB) joined the movement in July and the Bank of England accelerated the pace last week by raising 0.50%. Investors, however, play the anticipation. Looking at the yield curve, they expect the Fed to continue raising rates (at a slower pace) from 2.25%-2.50% to around 3.25%-3.5 % next spring. The Fed would then lower its rates again starting next summer. This contradicts the members of the Fed who did not foresee a rate cut before 2024 in their latest projections. Loretta Mester, president of the Cleveland Fed, even mentioned at the beginning of August the possibility of a key rate at more than 4%. However, it is not unusual for markets to respond more quickly to changes in the economic environment. On the one hand, the relapse in commodity prices since the peaks of May-June (-25% for Brent oil, -24% for copper, -39% for wheat) is likely to curb inflation , especially in the United States which does not face a real risk of gas shortage like Europe. Moreover, the current economic slowdown is also starting to weigh on the job market. Both in the European Union and in the United States, the unemployment rate has not fallen since April. The bond markets are thus anticipating less pressure from wages on prices. This expected easing of inflation and interest rates bodes well for growth stocks. Are they gone for good? This is what JP Morgan’s strategists seem to believe who believe that they are now “more interesting” with certain stocks showing “downright cheap” valuation levels. UBS is more cautious and believes a lasting improvement in sentiment is unlikely until the Fed has enough evidence of lower inflation to confirm that an end to rate hikes is in sight. Finally, on the side of Goldman Sachs, strategists are still reluctant to reposition themselves on growth stocks and favor quality stocks. According to MSCI, these are companies that show good profitability, sustainable growth and a good financial situation (limited debt). If we observe the evolution of growth stocks, investors seem to be positioning themselves with quality criteria in mind. Apple, for example, has already reduced its losses since the beginning of the year below 10%. And stocks that manage to provide reassurance about the sustainability of their growth and profitability are clearly rewarded. Uber thus soared nearly 40% in one week after announcing a 105% jump in quarterly revenue and, above all, its first positive free cash flow. The platform company, which now has more than 120 million monthly users, hopes to be able to self-finance its investment projects in the future. Tesla (+36% in one month) also rebounded sharply despite the decline in sales in the second quarter. Elon Musk expressed confidence in improving supply chains and promised a record second half. In Europe, LVMH has rebounded 28% since mid-June and has almost erased its loss in 2022 following the announcement of its half-year figures marked by organic growth of 21% and a jump of 23% in its net profit. The world number one luxury also raised its interim dividend by 67% (to 5 euros per share), a sign of its confidence in its prospects. Conversely, companies that failed to reassure were (harshly) sanctioned. HelloFresh, the world leader in meal boxes, hit new lows at the end of July after being forced to cut its annual forecast. More broadly, many companies that have directly benefited from confinement and teleworking are lagging behind. Meta Platforms (Facebook) is also failing to rebound as its revenues fell by 1% in the second quarter and its development strategy in the metaverse still leaves observers doubtful, while weighing heavily on its profitability. In another area, Beyond Meat, a specialist in meat alternatives, also faltered again last week after quarterly figures marked by a decline in its turnover and a widening of its losses, all of which horrifies the markets (see graph on previous page). Even if the environment seems to be becoming more favorable to growth stocks, a certain degree of caution is therefore still in order. The two main criteria to keep an eye on are the sustainability of growth and profitability (or at the very least the outlook for profitability in the short or medium term). The two obvious choices here are Apple and Microsoft, but these titles have also already recouped almost all of their losses. Looking at companies that are both members of the MSCI Growth and MSCI Quality indices, a few other names stand out. At the global level, we note in particular the specialist in graphics chips Nvidia, the parent company of Google Alphabet or the leader in payment cards Visa. At the European level, the names that stand out are the Swiss food giant Nestlé, the world leader in luxury LVMH, the Dutch specialist in equipment for the semiconductor industry ASML, the pharmaceutical groups Roche and Novo Nordisk as well as the British specialist Diageo spirits.