Growth stocks have gotten hit hard, but this looks like a buying opportunity.
Since its 2021 peak in early February, theRussell Growth 2000,an index of smaller capitalization growth stocks, is down more than 5%. TheVanguard S&P 500 Growth Index Fund ETF(VOOG) is down about 4% from its yearly peak hit around the same time.
Rising interest rates have done most of the damage, with the 10-year Treasury yield up to as high as 1.41% Wednesday from 1.1% in early February. Higher rates erode the value of future cash flows, but more so for growth companies than for more mature businesses because growth firms expect to see a large share of their profits come farther down the line. Smaller, less profitable names are most sensitive because they are largely less profitable at present.
There’s plenty of backbone to the buy-the-dip argument.
Growth stocks bounced off of their intraday low Tuesday morning as Federal Reserve Chairman Jerome Powell spoke.Powell emphasized the Fed’s policy to keep interest rates lowfor as long as the economy needs, as the recovery is not yet fully through. Interest rates backed off of their general rise and right on cue, the Russell 2000 Growth Index jumped a few percentage points from its low on the day. “Growth/momentum rebounded sharply following Fed Chair Powell’s testimony yesterday morning,” Chris Senyek, chief investment strategist at Wolfe Research wrote in a Wednesday note. So if rates calm down, growth stocks may very well resume rising.
Powell’s comments matter. Rates may not exhibit too many fast jumps on an ongoing basis. “The Fed’s extreme dovishness persists—buy liquidity beneficiaries,” Senyeck wrote. Simply put, Senyeck recommends buying stocks that benefit when rates are low and liquidity, which often means the easy availability of money, is flowing. That’s against theWall Street consensus viewthat rates are on a sustainable path higher, as inflation and economic demand strengthen. Powell must remind that the Fed is committed to its current policies that support low rates, butinvestors are preparing for the Fed to alter its position at some point within the next year or so. Higher rates will likely remain a pressure point for growth valuations.
Still, there’s a silver lining in favor of the call for growth stocks. Sure, valuation pressure may persist, but sales and earnings growth is the other side of the equation—and those look strong. So whilemultiples on those near-term results may have limited upside, the results, themselves may impress.Okta(OKTA), for example, a $34 billion by market cap provider of business data management, is expected to see sales grow by more than two-thirds over the next 3 years, while turning profitable by 2023, according to FactSet data. The stock is down almost 10% from its 2021 peak hit in February. It does trade at a rich 41 times 2021 sales estimates and may see more pressure on that multiple.
Keep watching the dance between valuations and near-term profits.