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A confluence of easy money from central bankers and new technologies from Silicon Valley made the 2010s a golden age for high-flying growth stocks. But as the decade comes to a close, some investors are becoming more cautious, eyeing more defensive investments as well as value stocks.
The shift to stocks with more solid fundamentals and lower price-to-earnings ratios follows the mistakes that sometimes come from investing based on growth expectations rather than an insistence on profitability.
“We still think the greatest risk in the equity market remains in growth stocks where expectations are too high and priced,” Morgan Stanley analysts wrote earlier this month, suggesting a shift from growth to value stocks.
In a November note, Credit Suisse analysts also recommended this shift: “We now believe investors would be well served to reposition their portfolios toward Value stocks over … Growth.”
How far a swing from growth to value goes depends on whether investors believe the economy is growing, slowing, or just sort of hanging in there. For this reason, the growth investing trend of the past decade may well continue into the next, some analysts say.
“Value stocks have fared best during periods of very strong or very weak economic activity,” Goldman Sachs analysts wrote in a note to investors in October. “Sustained value stock outperformance therefore appears unlikely unless the pace of economic growth either rebounds sharply … or falls into a recession. We believe neither of these scenarios is likely.”
To be sure, as a new decade begins, the economy continues to deliver an indecipherable mixture of data points and economists and analysts are divided as to where it’s headed.
On one hand, stocks are at record highs, a slowing global economy appears to be improving, U.S.-China trade tensions have eased, and it appears a hard Brexit may be avoided. But on the other hand, all of these positives could turn at any time, accelerating a shift to more conservative strategies that has already begun.
The growth stock decade
In a decade characterized by ultra loose interest rate policies from the Federal Reserve, growth stock investing was destined to dominate. Money to help banks recover from the 2008 financial crisis found its way into the market and favored these stocks.
Since the beginning of the decade, the Russell 1000 Growth index rose 260% compared to the Russell 1000 Value index, which rose 139%. The broader S&P 500 during that time was up 189%.
As the decade progressed, investors tuning into CNBC heard increasing references to FANG, or sometimes FAANG, stocks.
FANG an acronym for Facebook, which dominates social media; Amazon, which leads in e-commerce and cloud-computing solutions; Apple, with it’s ubiquitous iPhones; Netflix, which rules streaming video, and Google, which has become synonymous with search. All of these companies made their mark on the way people live.
For much of the decade, investors only needed to know this one acronym to succeed, particularly in the latter half of the decade. FANG stocks overwhelmingly outperformed the S&P 500 and helped carry the index to its highs. These are large-cap companies that have grown steadily and transformed entire industries and the way people live their lives.
Technology stocks outpaced the market for the decade, and it was not all just based on hopes. Semiconductor companies were the best-performing sector of all, rising 377% over the past ten years, as mobile phones, tablets and laptop computers evolved into everyday household necessities.
Boosted by buyouts
An era of ultra-low interest rates gave U.S. companies an unprecedented opportunity to boost their share prices with stock repurchases and higher dividends. This trend has reached a point when is may no longer make economic sense.
“Companies (through the combination of buybacks and dividends along with weaker earnings growth) have for the last three quarters been paying out more than the income they are generating,” analysts from William Blair wrote in a November note.
According to research from Societe Generale, S&P companies bought back the equivalent of 22% of the index’s market capitalization over the past ten years, and tech companies dominated the buyback wave.
Stock buybacks hit a record in 2019, driven not only by low borrowing costs, but also by a substantial repatriation of cash held abroad after President Donald Trump’s tax reform measures, the Societe Generale analysts said.
The trend, however, clearly began to slow in the later half of 2019.
“The overall level should gradually normalise, from the abnormal amounts seen over the past few quarters,” Societe Generale analysts wrote.
Investing discipline gets lax
In a frothy market that rewards financial engineering and growth trajectories over profitability, investors can lose sight of the balance sheet.
Corporate debt levels, for example, have swelled from nearly $4.9 trillion in 2007 to nearly $9.1 trillion halfway through 2018, according to Securities Industry and Financial Markets Association data.
It hasn’t been a problem with persistently low interest rates, but it could become one if the economy ever shifts to a rising interest rate environment. The trend also stands as a reminder the growth stock boom as well as the longest bull market in history have been boosted with borrowed money.
As the decade came to a close, there were signs investors were becoming undisciplined amid the boom. Several high-profile initial public stock offerings, for instance, flopped spectacularly.
An upstart company touting a plant-based alternative to beef, Beyond Meat, went public at $25 in May, saw its stock soar to nearly $235 by July, and now trades for about $77 a share.
Peloton, which sells pricey stationary bikes and treadmills with online exercise class subscriptions, went public in October at $29 and swiftly saw it’s stock drop by more than 10%.
Peloton has since recovered to about $30, but that’s hardly breath-taking in a raging bull market. Its lackluster debut on public markets had ripple effects, too. For one, it persuaded Endeavor Group Holdings, an entertainment and talent agency company, to delay its plans for an IPO.
A WeWork office in San Francisco
Kate Munsch | Reuters
What may be remembered as the most notable foible capping the decade of growth stocks, however, was the parent company of WeWork, which has been attracting billions of dollars in private equity to open up co-working spaces across the country.
WeWork filed for an IPO in August and by November it cut its valuation from $47 billion down to $5 billion, removed its flashy CEO Adam Neumann and laid off 2,400 employees.
Michael Wilson, an equity strategist for Morgan Stanley, cautioned that the WeWork debacle may mark something more than just the folly of a single company. It “is reminiscent of past corporate events marking important tops in powerful secular trends,” he wrote to investors in late September.
Wilson pointed to United Airlines’ failed leveraged buyout in October 1989, “which effectively ended the high yield/LBO craze of the 1980s.” There was also the AOL Time Warner merger in January 2000, “bringing the Dotcom bubble to a close.” And then there was the failure and subsequent sale of Bear Stearns in March 2008, “which signaled the end of the financial excesses of the 2000s,” Wilson wrote.
WeWork, Wilson argued, could be one of these moments.
Perhaps the days of growth stock outperformance will not end with the decade, but for now it appears a rotation into value stocks is likely to continue.
“While the rotation towards value started in September … we think it is still in its early stages,” said Marko Kolanovic, J.P. Morgan’s global head of macro quantitative and derivatives strategy, wrote in a December note. He also said in a November note that he expected this rotation to continue into the first quarter.
In any case, with indexes at record highs, and stocks at hefty valuations, investors will likely be more careful in the quarters to come.
“The days of endless capital for unprofitable businesses,” are over, Wilson wrote. “It was one heck of a run, but paying extraordinary valuations for anything is a bad idea, particularly for businesses that may never generate a positive stream of cash flows. If you ask me, that’s just common sense and it’s a good thing if the markets go back to a more disciplined mindset.”