Dynamic trends ignite optimism for growth stocks

Mark Baribeau August 21, 2023 08:28

While 2022 was challenging for equity markets, growth stocks rebounded in the first half of 2023, driven by resilient corporate earnings, moderating inflation, and strong consumer demand. Growth stocks generally tend to face downward pressure in an inflationary environment, particularly when the speed of interest rate hikes is rapid, which was the primary culprit for weak equity performance in 2022. But receding inflation, signs of slowing economic growth, and the Fed signaling a rate-hike pause fueled a rotation back toward growth stocks with solid earnings and durable revenue growth.

Technology companies benefited tremendously from the COVID-19 pandemic due to significant demand related to work-from-home policies. After a vast amount of spending during the pandemic, the sector began to weaken in late 2022. This trend continued in early 2023 as technology companies reduced spending in preparation for an economic downturn. Caution for the sector is warranted in the short term given the ongoing volatility and industry consolidation. However, we are selectively finding opportunities based on long-term underlying strength in business models and solid revenue trends.

Valuation Reset Boosts Backdrop for Growth

While equity valuations were reset harshly last year, the readjustment has created a favorable backdrop for growth stocks, which should be better positioned to outperform as economic growth moderates. While growth companies began the year with neutral valuations and more visible earnings outlooks, the market environment may remain challenging in the second half of 2023 given the ongoing geopolitical uncertainty, tighter credit standards, and spillover from the banking turmoil. Despite the potential market slowdown, we believe that more normalized valuation levels will favor growth stocks with visible, durable earnings growth as the Fed ends its tightening policy. Consensus estimates are also signaling a strong corporate profit rebound for growth stocks compared to value stocks, which tend to be more vulnerable to the cyclical downward pressure of an economic slowdown.

Innovative and Resilient Secular Trends

Sectors that exhibit strong, durable earnings growth and powerful new product cycles are expected to thrive in today’s volatile environment. Four secular growth areas where we see tremendous opportunities include:

• Artificial intelligence (AI): The emerging development in generative AI will be a transformational technology, enhancing productivity for businesses and end customers. Although in the nascent stages, AI will likely be embedded into business models and proliferate through every sector and industry as it evolves. We think semiconductors and infrastructure to support the massive computing power needed for AI-enabled applications is the most tangible way to invest in the space now.

• Global consumer brands: The high-end consumer is less vulnerable to the ebb and flow of economic conditions than the average consumer. We remain optimistic that global luxury consumer brands with strong direct-to-consumer business models, solid inventory control, and robust pricing power will continue to be resilient in a slowing economy.

• Electric vehicles (EVs): As the shift to EVs accelerates in the coming years, EV manufacturers, battery producers, and supporting infrastructure companies are expected to significantly benefit from the rising demand.

• Healthcare innovations: Advancements in the ability to diagnose, monitor, and treat diseases with personalized therapeutics are creating a broad set of investment opportunities, with potential blockbuster treatments for diabetes, obesity, cancer, and rare diseases in drug companies’ research pipelines.

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Mark Baribeau

Head of Global Equities, Jennison Associates, PGIM