Growth stocks like Apple (ticker: AAPL) and Tesla (ticker: TSLA) seem to be having their time in the sun again despite the constant ebb and flow experienced in the past four months. Right now, the stocks seem to be experiencing their time in the sun as the economy looks like it could slow down.
The cycle is one most investors know all too well: a rebound for growth stocks after an economic growth spurt which the Federal Reserve then decides to restrict.
The Nasdaq-100, an index that tracks large-market capitalization and fast-growing technology stocks, touched an all-time high of 16,573 on November 19 and began its downward trajectory until it hit 13,046 on March 14. It was a 21% decline in 120 days.
Apple, currently the company with the heaviest weight on the index, dropped 18% from January 3 to March 14. Tesla (ticker: TSLA), presently the fifth-largest holding, dropped an astonishing 38% from Nov to March 14.
The drop in growth stocks was worse compared to stocks in the Dow Jones Industrial Average and the S&P 500, both of which are mostly comprised of value stocks. The Dow Industrials lost 11%, and the S&P 500 fell 13%.
The Chairman of the Federal Reserve, Jerome Powell, indicated that the central bank would raise interest rates seven times this year and end its bond-buying program that previously hit $120 billion a month. True to his word, the Fed slowed down its bond buyers and instituted the first of seven in rate hikes.
Without access to that money, the bond market reduces bond prices and lifts their yields. Higher long-dated bond yields make future profits less valuable- growth companies are typically valued on the assumption that they’ll make sizeable earnings many years down the line.
Although bond yields are now higher, growth stocks are gaining due to the fact that the central bank has put its money where its mouth is.
The Nasdaq-100 gained 11% from its bottom, with Apple at 13% and Tesla at 30%. One of the reasons for this is the greater certainty in the Fed’s next moves. Growth valuations, or stock multiples on expected earnings for the next year, have already shown much of the rise in yields, as multiples have declined.
“Growth and high-multiple tech have spent much of 2022 being punished as rates have risen, but they are bouncing back now on some hopes for Fed clarity,” said the founder of Sevens Report Research, Tom Essaye.
All this might look a little confusing and even contradictory for rookies in the investing game. But expert investors consider this growth revival normal considering the stage of economic growth.
Under normal circumstances, before the Fed tightens monetary policy, growth stocks fall behind their value counterparts. The ostensible reason for this is the fact that strong demand drives consumer prices up, and value stocks respond to strong earnings growth when the economy picks up steam.
Afterwards, the Fed attempts to control inflation by lifting short-term interest rates, leading to a slowdown and even a recession. In such cases, the slightest easing in Fed controls works as an incentive for investors to ditch value stocks for growth ones.
A slowing economy can have the effect of capping long-dated bond yields. Overall, growth valuations stop declining, allowing their expected profit growth to force stock prices higher.