*By Gary Black / Calamos Investments
Chair Yellen’s comments in March that short-term rates could move higher early next year, combined with weak economic data, caused a sharp rotation away from growth stocks, especially the longer-duration names we tend to favor (see our post “When Stocks Behave Like Bonds”). There’s been ongoing debate about where we are in the market and economic cycles. Growth has recovered some following stronger economic data, but still trails value year-to-date.
In our view, the economy looks to be positioned for steady growth: not too hot and not too cold. Chair Yellen vowed at her press conference today to keep interest rates low for a “considerable time” after current quantitative easing ended, given continued slack in the economy and inflation that remains below the Fed’s 2% target. Against this economic backdrop, we’ve had a balanced positioning of secular and cyclical growth names. Valuations of growth stocks relative to non-growth stocks remain compelling by historic standards, and we see more room for P/E expansion in growth stocks as the economic recovery strengthens.
The Business Cycle and Equity Market Performance
Valuations Support the Case For Growth
Large-Cap Growth Stocks Relative to Non-Growth Stocks, Ratio of Forward P/E Ratios
1976 Through Late May 2014
Past performance is no guarantee of future results. Source: Corporate Reports, Empirical Research Partners Analysis. Capitalization-weighted data.
This view of growth’s potential is gaining currency: Late yesterday, Empirical Research Partners shifted its forecast from a neutral regime (3 out of 5) to growth-tilt regime (4 out of 5). This is the first time since 2008 Empirical has felt that growth would outperform value. Empirical has long made the case that getting the regime correct (“knowing what game you are playing”) is critical to knowing what quantitative tools will work, and when.
In every business cycle going back to 1970, growth has outperformed value in the last 12 to 36 months of the cycle. This has usually coincided with the following conditions:
- Flattening yield curve
- Narrow but widening valuation spreads
- Breadth of companies showing margin expansion narrows
- Market rewards high capital spending ratios
- Market rewards high price volatility (on a risk-adjusted basis)
- Market rewards earnings and price momentum (also on a risk-adjusted basis)
Growth Stocks Have Typically Outperformed During Late Cycle
Large-Capitalization Growth and Value Stocks
1953 – Mid April 2014; Recessions indicated by shaded areas
Past performance is no guarantee of future results. Source: Empirical Research Partners Analysis. Equally weighted data used for the lowest two quintiles of price-to-book ratios compared to growth stocks.
We expect the merits of growth equities will garner increased recognition as economic growth accelerates in the months ahead. Still, we believe that there will be disparities among companies’ performances. In this environment, we expect our high-conviction, fundamentally driven approach will allow us to pick the winners from the losers within this more attractive growth universe.
Gary Black is the Executive Vice President & Global Co-Chief Investment Officer of Calamos Investments.
Past performance is no guarantee of future results. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable. The views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.