How long will the correction in growth stocks last?
Chart of the week
The chart shows the outperformance of growth stocks against the broad market index in the USA, the S&P 500, since 1926. Even growth stocks cannot rise forever. In the past there were two peaks, 1970 and 2000 the Tech Bubble. Now we are back to similar valuation heights.
Why this matters
Growth stocks have been the majority driver of returns in the U.S. in 2020 and 2021. However, a correction has been underway since November 2021. The question many investors are asking is whether growth stocks are now a good buy since November, and especially after last week's sharp correction?
The chart above suggests that we are seeing a trend change here that could last for years. Growth stocks tend to be highly leveraged or not yet making profits and have to finance all their business with debt. High interest rates are hitting them hard.
The chart shows interest rates in the USA since 1960. The trend of over 30 years of falling interest rates now seems to have been broken. It can therefore be assumed that growth stocks will also correct further and that value stocks are now the better place to invest.
Nervous markets: earnings season is over
The financial markets had already put the Ukraine crisis behind them and refocused on the current economic situation with high inflation and rising interest rates. Increasingly strident rhetoric from Moscow and uncertainty about what Putin will say on May 9, Russia's Victory Day against Nazi Germany, is now causing great uncertainty.
The interest rate decision of the U.S. Federal Reserve to raise interest rates by 50 basis points had been expected so, but after the negative GDP growth figures published the week before, but some market participants have expected a less strong signal from the central bank. The risk that the central bank might raise interest rates too firmly and send the economy into recession is growing.
The chart shows the development of the U.S. stock market 52 months before and after the first interest rate step by the Federal Reserve since 1994. The thick blue line shows the current development and slightly grayed out the developments of the last 4 interest rate hike cycles.
The current correction is already the strongest of the past 5 cycles. Of course, the previous cycles were not overshadowed by a war. Nevertheless, the chart shows that the market reaction, purely based on the interest rate steps of the central bank, is already exaggerated. Should the negative influence of the Ukrainian crisis weaken, a counter-reaction of the markets to the upside is to be expected.
Although the end of the reporting season of the companies with the earnings developments for the first quarter of 2022 was quite positive, the statements of the companies did not help to break the negative bias that was described above.
The chart shows investors' expectations before the end of the quarter and how earnings were then published. The last 7 quarters and the two coming quarters until the end of 2022 are shown in color.
At the beginning of this earnings season, corporate earnings in the U.S. were expected to grow by an average of 5.5%. Delivered was 8.7%. 81% of the companies were able to report higher than expected profits.
This is actually a very good picture. Nevertheless, some negative examples like Netflix have clouded investor perception. Investor sentiment is currently so negative that good news is being ignored.
The outlook for the next few quarters is also positive. For the second quarter, an increase of only 5% is expected. Even there, many companies are likely to outperform. It gets a bit sportier with the expected 10% increase for the third quarter of 2022. With Americans' disposable income plummeting, due to high inflation and mortgage rates, this figure should be hard to beat.
Commodities: Is it too late to invest now?
Commodity prices have risen very sharply in recent months. We will try our hand at a historical classification of this price increase.
The chart shows the performance of the broad CRB commodity index in economic recoveries since 1873. The current rise is historically one of the highest in history. Only many times has the rise gone further and higher. The current rise is fueled by post-Covid problems with supply chains and the war in Ukraine. Nevertheless, a comparison with the past suggests that we have already seen the biggest increase and we are near the end of the rise.
The chart shows the price increase of selected commodities (colored) and the broad GSCI commodity index (black). Shaded in gray are the returns of individual commodities as they recover from a 5-year low since 1784.
The current rise in commodity indices is primarily driven by the rise in oil prices. We are currently seeing the strongest increase in oil prices after a 5-year low since 1973. Many countries are currently intervening in the market by cutting taxes on energy sources and opening storage facilities with strategic reserves. We assume that the increase of the oil price can be broken thereby lastingly.
The situation is somewhat more difficult for other commodities and in particular for wheat prices. A further increase is to be expected there.
The chart shows the out-performance of energy and commodity companies against the S&P 500. It shows how long-term commodity trends are. These usually last 8-10 years. After a steep out-performance from 2000 to 2008, there was a long under-performance from 2008 to 2020. Now that the trend has reversed, there is a good chance for a longer out-performance of this sector.
Due to the strong special movements described above, we currently assume that the average commodity prices will now consolidate somewhat. However, there is a high probability that they will resume the uptrend after a few months.
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