Are Good Times Gone for Growth Stocks?

Are Good Times Gone for Growth Stocks?

January 21, 2022

Tech has taken a drubbing of late as traders have switched allegiances from growth stocks to value stocks. The tech-heavy NASDAQ composite index careened into correction territory on Wednesday—down 10% from its November high—before dipping another 1.3% on Thursday.

The pain is explained primarily by expectations. With multiple interest-rate rises, slower growth and lingering inflation on the horizon, pandemic-era favorites have lost their luster while value plays like financials and energy take their turn in the limelight. Of course, this doesn’t make perfect sense since slower economic growth would favor growth stocks. But right now, the prospect of higher interest rates, spurred by inflation, is driving trader sentiment.

Notably, in this volatile state of affairs we’ve heard investors like Jeremy Grantham claiming the current blowoff is just a first step toward a massive market revaluation. Meanwhile, economists like Janet Yellen, former Federal Reserve chair and current Secretary of the U.S. Treasury, think inflation will recede close to 2% by year-end.

For investors (rather than traders), sell-offs may be unsettling, but they do have an upside: They present buying opportunities for disciplined mutual fund portfolio managers like those we’ve partnered with. Many stocks have fallen recently because others have—not because their fundamental businesses are in trouble. It’s just those kinds of companies that tend to lead in market rebounds. We take a very long and patient view of short-term market disruptions and hope that you will as well.

Total Returns

Bonds Do Bounce Back

Stocks have fallen and so have bonds. Worries about persistently high inflation have driven interest rates higher, and when rates rise, bond prices fall. However, the reactionary response of bond traders is, again, a short-term phenomenon that doesn’t augur future declines.

History suggests bonds can still generate gains in rising interest-rate environments even as policymakers hike short-term interest rates. Looking back over the last 30-plus years, bonds made money during each of the periods when the Fed was raising interest rates: The Vanguard Total Bond Market Index fund rose 8.0% in the 1994 to 1995 period, 12.9% in the 1999 to 2000 rate-hike era, 16.0% during the mid-2000s and 13.4% from 2017 to 2019.

The Federal Reserve’s plans to both end its bond-buying stimulus and raise short-term interest rates may have caused traders to reflexively sell, but that probably isn’t the proper strategy for an investor with a time horizon greater than the end of the trading day.

Avoid Bonds When the Fed Is Hiking Rates?
Note: Chart shows fed funds rate and periods of tightening from 12/31/89 through 12/31/21. Bond returns during periods of tightening are those of Vanguard’s Total Bond Market Index fund. Sources: The Federal Reserve, The Vanguard Group, Adviser Investments.

Is the NASDAQ Rout Rational?

This week’s reader question is about the tech stock sell-off:

Is the recent NASDAQ rout rational, and how long might it last?

Portfolio Manager Adam Johnson: 

Change can be difficult to stomach. After pumping trillions in liquidity into the banking system during the pandemic, the Federal Reserve is poised to pull the punch bowl from the party.

One knee-jerk response? Traders are dumping growth stocks—particularly technology stocks—with abandon. In recent weeks, nearly 40% of the 3,000 stocks in the NASDAQ composite index have fallen at least 50% from their all-time highs. More than 220 well-known companies with market capitalizations of at least $10 billion have fallen 20%. Not even stalwarts like eBay, Netflix, PayPal, Salesforce and Walt Disney have escaped the carnage.

Traders are selling on the assumption that higher interest rates will raise borrowing costs and make future earnings worth less. Fair point—but are they overreacting?

I think so. The fear pendulum has swung too far. Even if the Fed raises rates by 0.25% four times this year, the fed funds rate will be just 1% to 1.25%, and interest rates, when adjusted for inflation, could remain below zero for years. That doesn’t put up much competition for a company that is growing its earnings quarter after quarter—earnings that, after inflation, are still strongly positive.

We’ve seen so-called “taper tantrums” before—extreme selling of stocks ahead of hawkish policy changes at the Fed. Here’s the thing: Higher interest rates aren’t always bad for stocks. On the contrary, the Fed has initiated four hike cycles since 1990, and in each case, stocks gained value. Specifically, the S&P 500 index rose an average of 10.6% as the Fed lifted borrowing rates, and in three instances, stocks went on to rally significantly after hikes were complete.

Rate Hikes and Rallies
Note: Chart shows index level for the S&P 500 as well as the fed funds rate on a weekly basis from 12/28/90 through 1/14/22. Gains displayed during rate-hike cycles do not include reinvested dividends.
Sources: Barron’s, the Federal Reserve.

Curiously, falling interest rates generally signal the more precarious environment for stocks, perhaps because the economy is already in trouble and the Fed is playing catch-up.

Change always introduces uncertainty, but history indicates that these moves by the Fed aren’t as bad as the present market drops suggest. There is a bottom in here somewhere and many potential buying opportunities.

Adam Johnson is Portfolio Manager of Adviser Capital American Ingenuity.

Graphic of the Week: The Formula for Fed Action

We monitor a wide range of data to form our outlook on the market and the broader economy—every other week, we’ll spotlight one indicator our analysts have found informative.

Director of Research Jeff DeMaso By Director of Research Jeff DeMaso

It really shouldn’t be a surprise that the Federal Reserve is gearing up to raise the fed funds rate. The central bank has a dual mandate of price stability and full employment. With consumer prices having risen 7% in 2021 and the unemployment rate clocking in below 4%, the Fed is now turning its sights on price stability. Policymakers’ escalated inflation-fighting timeline now calls for a rate hike as soon as this March. This graphic says it all.

Formula for Fed Action
Source: Adviser Investments.

 

Ask Us a Question!

We’re always interested in the topics or themes you might like us to comment on. As much as we try to cover the investment and economic fields every week, we know there’s still more that you might want to hear about. Ask us a question about investing, the markets or financial planning and one of Adviser Investments’ experts will answer it in a future edition of The Week in Review. CLICK HERE NOW TO POSE YOUR QUERY.

Financial Planning Friday
4 Ways to Maximize Your 401(k)

401(k) plans are common these days—and if you’re contributing 10% to 20% of your paycheck, you’re ahead of the pack. But while you may already have the basics down pat, taking a deep dive into the mechanics of 401(k)s can unlock one of the most powerful financial planning tools at your disposal. Here are some tips to get started:

  1. Expand your investment options. Compared to a brokerage account or IRA, your investment options with a 401(k) are typically limited to a small list of mutual funds or exchange-traded funds (ETFs). But that list often changes from year to year as employers add or remove funds, so it’s worth doing an annual review to see if you’ve got better options for your investment needs. More significantly, with some plans it’s possible to add a brokerage link inside of your 401(k), opening up a far wider investment universe. (Contact your portfolio team for more information if your plan offers a brokerage link and you’d like some suggestions.)
  2. Consider a Roth 401(k). More and more 401(k) plans offer a Roth option, but only about 25% of 401(k) savers are using one. We think the rest are missing out. A Roth 401(k) has all the advantages of a Roth IRA, with one big difference—there are no income phaseouts. By splitting 401(k) contributions between a Roth 401(k) and a traditional 401(k), high earners can get tax benefits now (by deducting traditional 401(k) contributions) and later (with tax-free distributions of your Roth 401(k) when you retire).
  3. Know your plan’s vesting requirements. Any contributions you make to your 401(k) vest immediately. That money is yours even if you leave the company the next day. Contributions by your employer are often subject to either a cliff or graded vesting schedule, however. Cliff vesting happens all at once (i.e., after five years of employment); graded vesting happens gradually (20% each year for the first five years you work at the company, etc.). If you’re considering a new job, be aware that leaving a company before your employer’s contributions have vested can mean leaving a significant sum behind, as nonvested 401(k) assets are typically forfeited.
  4. Understand the rules for accessing your 401(k) funds. Tapping into your 401(k) early should be a last resort. The money is earmarked for retirement and ideally should be left untouched until that time. Still, it’s important to know what provisions are available if you need to access your funds fast through a hardship withdrawal or a loan. A loan may seem like a better deal: Hardship withdrawals are treated as taxable income and incur a 10% early withdrawal penalty; loans do not. But that distinction only stands if you stay with the same employer for the entirety of the repayment period. Switch employers or resign and taxes and penalties kick in.

Talk to us if you have questions about making the most of your retirement plan. We’re here to help. And did you know that Adviser Investments can manage assets held within your employer-provided accounts, such as your 401(k), 403(b) and 457 plans, even if you’re still contributing? If this is something you’re interested in, your adviser can answer questions and help you get started.

Our Quarterly Webinar: Diversification Is Dead…and Other Modern Market Myths – Register Now 

2021 was a record-setting year for the stock market, but diversified investors may have felt left behind. Our experts will explain why we think 2021 was an outlier and what 2022 has in store—including what we’re doing to prepare for greater market volatility.

Join us on Wednesday, Jan. 26, from 4:30 p.m. to 5:30 p.m. EST for our next quarterly webinar, Diversification Is Dead…and Other Modern Market Myths, to learn why our investment strategists think volatility is here to stay even as the economy continues to recover. Chairman Dan Wiener, Director of Research Jeff DeMaso and Chief Investment Officer Jim Lowell, among others, will discuss the current market environment and their outlook for the months ahead. In addition to a market recap and commentary, this interactive webinar will allow our team to answer your questions and discuss your concerns. Click here to register now!

Adviser Investments in the Media

This week, Traditional Fund Intelligence spoke to Director of Research Jeff DeMaso about Vanguard’s expanding ESG fund lineup, while Financial Advisor IQ queried Chairman Dan Wiener about Vanguard’s plans for more fee cuts. Chief Investment Officer Jim Lowell guested on Bloomberg’s “The Tape” podcast to discuss 2022 investment strategies in the face of rate hikes.

In addition, Yahoo! Finance took note of Adviser Investments’ recent launch of the American Ingenuity aggressive growth strategy and Portfolio Manager Adam Johnson appeared on Cheddar News to make sense of recent declines in the stock market.

In this week’s Market Takeaways, Senior Research Analyst Liz Laprade told us why rising rates can be a mixed bag for bank stocks, while Steve Johnson offered his thoughts on the stock market sell-off.

Looking Ahead

Next week is chock-a-block with reports: Reads on the manufacturing and service sectors; several real estate indicators (home prices, new home sales, pending home sales); durable and capital goods orders; inflation gauges; Q4 2021 GDP; and a bevy of consumer data (income, spending, savings, sentiment and confidence). But the biggest events of the week will be the Federal Reserve’s rate-hike meeting and Chair Powell’s press conference.

As always, please visit www.adviserinvestments.com for our timely and ongoing investment commentary. In the meantime, all of us at Adviser Investments wish you a safe, sound and prosperous investment future.

About Adviser Investments

Adviser Investments is a full-service wealth management firm, offering investment managementfinancial and tax planningmanaged individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have nearly 4,000 clients across the country and over $7 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. Our minimum account size is $350,000. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.


Please note: This update was prepared on Friday, January 21, 2022, prior to the market’s close.

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