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NASDAQ in bear market as gravity reasserts itself on growth stock valuations

by LLB Finance Reporter
28th Apr 22 12:14 pm

This week has seen a renewed sell-off in global equities with much of the pain again felt by growth stocks. Here Jason Hollands, Managing Director of Bestinvest, the online investment platform, assesses the reasons behind and fallout from the battering taken by certain equity sectors this year.

While the S&P 500 index of large US companies is down 12.77% year-to-date, as of yesterday’s close the NASDAQ Composite index had declined by 21.12% and is down by more than 20% since its November – so officially a bear market.

Things are even worse for the FANG+ Index of ten major ‘new economy’ stocks that have been so popular with investors in recent years and were pandemic winners. The FANG+ Index is down by a third since its all-time high at start of last November and has declined by 30.69% year-to-date.

Below is a table of the share price returns of the FANG+ constituents YTD, as well as tech giant Microsoft which is not in the FANG+.

FANG+ Stock YTD performance

Company Share Price Return YTD
Twitter +14.02%
Apple -13.98%
Baidu -17.55%
Amazon -18.92%
Alphabet (Google) -21.17%
Alibaba -23.26%
Tesla -26.53%
NVIDIA -38.86%
Meta (formerly Facebook) -48.32%
Netflix -68.44%
   
Not in FANG+  
Microsoft -15.39%

While there are company specific factors at play such as Elon Musk’s takeover bid for Twitter, the savaging of Netflix after revealing a decline in subscribers and Amazon this week undershooting revenue expectations, there are bigger forces at play.

Equity market investors are confronted by a ‘wall of worry’ at the moment, with rampant inflation compounded by the Russia’s war with Ukraine and brewing concerns that China’s renewed round of draconian lockdowns as it pursues a ‘zero COVID’ strategy will lead to factory closures and global supply chain shortages. The war in Ukraine and Chinese lockdowns risk further feeding the global inflationary impulse.

One reason why the financial markets worry about high inflation, is that that it is forcing the hand of central banks to take action to tame it by raising interest rates and reversing the massive stimulus programmes that flooded the global financial system with a torrent of cheap money through the pandemic and prior to that the global financial crisis.

The mighty US Federal Reserve Bank last month raised US interest rates for first time since 2018 as it seeks to tackle the highest inflation in forty years. It is widely expected to increase interest rates by 50 basis points at its next meet in May, as well as put its stimulus programme into reverse gear by reducing its balance sheet by $95 billion a month.

Markets are therefore factoring in the prospect of the most aggressive pace of monetary tightening in decades. For government bond markets, yields have surged higher in a short period of time. In July 2020, 10-year US Treasury yields were as low as 0.53% but they are now 2.87%.  Ten-year UK Gilt yields have also surged from a low of 0.11% in July 2020 to 1.87% currently.
The changing environment also has implications for the equity market, with some sectors proving more resilient to rising inflation and higher borrowing costs than others.

At the sharp end though are ‘growth’ stocks – the types of companies whose share prices rose substantially during the recent years of benign inflation and ultra-low borrowing costs. Fast growing companies are predominantly valued on expectations of the future cashflows they will generate, not just today’s profits. When borrowing costs were not far off zero, this favoured analysis of such companies, but inflation and higher borrowing costs creates uncertainty about the value of future money, so the historically high valuations of these types of companies are now being reassessed.

Private investors naturally gravitate towards the funds which have delivered the highest past returns and so many will have become heavily exposed to growth stocks in recent years. This will have been compounded by the growing popularity of ‘passive funds’ which track major indices like the S&P 500, since these plough money into the companies with the largest valuations, irrespective of whether or not these look expensive compared to history.

The chart below is revealing. It shows that since the start of the year, global equity markets – as measured by MSCI in USD $ terms – are down 13.0%, but companies with ‘growth’ characteristics have suffered a much more severe 20.4% drop. In contrast ‘value’ companies – typically those in ‘old economy’ sectors, churning out dividends, have proven much more resilient (down 5.6%). The latter types of companies have been widely ignored and dismissed as ‘boring’ by investors in recent years, but conservatively financed companies, paying out regularly dividends suddenly look at lot more appealing in the environment we are now in.

If there is a silver lining of sorts, it is that UK based investors have been partially shielded from the brutality of the US growth stock rout by currency moves. As the Fed has adopted a more hawkish stance, the Dollar has strengthened c.8% against Sterling and so currency gains on UK investors’ US – and global fund – holdings have helped soften the blow on underlying losses from US growth stocks.

While it is difficult to know how long the current turbulence for growth stocks will continue, inflation concerns and the prospect for rising interest rates are not going away any time soon. We are still in the foothills of a rate hiking cycle. Therefore, investors who have become too heavily exposed to growth stocks would be wise to consider a more balanced approach by introducing funds with greater emphasis on the valuations paid for companies and a focus on resilient dividend generators.

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