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Equity Perspectives

While FAANG anxiety hangs over the broader market, opportunities to uncover innovation in smaller-cap stocks and other growth sectors persist for active managers.

Large-cap growth stocks (as represented by the Russell 1000® Growth Index) had quite a challenging month in March, and continued to experience turbulence at the start of April, helping to pull the broader Nasdaq Composite Index into negative territory for the year.  But there’s much more to growth stocks than the familiar mega-cap technology names (the so-called “FAANG” stocks1) that were the primary cause of volatility.

Outside the brand-name tech behemoths, it is important to remember that transformative innovation, often found at smaller companies in other sectors beyond just tech, is alive and well. This especially is true of biotechnology and genomics, where development of ground-breaking therapies known as “precision medicine” is still in the early innings. But this potential also can be found in industries ranging from cloud computing and artificial intelligence to e-commerce.

In fact, smaller-cap growth stocks were the top “style box” performers in the month of March, recording positive gains in an otherwise turbulent month for equities and demonstrating that not all growth companies face the same challenges as the mega-cap names garnering headlines.  (See Table 1.)

 

Table 1.  Small-Cap Growth Stocks Outpaced Other Categories in a Challenging March
Total return by “style box” category for the month of March 2018

Source: Morningstar. Data as of March 31, 2018. Value, core, and growth segments of the large and small-cap categories are represented by style-specific components of the Russell 1000® and Russell 2000® Indexes, respectively. Mid-cap value, core, and growth segments are represented by the Russell Midcap® Value Index, Russell Midcap® Index, and Russell Midcap® Growth Index, respectively.

Past performance is no guarantee of future results. All indexes are unmanaged, include reinvestment of dividends and interest income, and are not available for direct investment. The style boxes shown are of equity indexes and are not representative of any fund or any particular investment. Please refer to “Important Information” regarding index information.

 

In short, after a prolonged stretch of mega-cap outperformance, market leadership within growth has begun to shift to companies at the forefront of innovation, which also often have lower market capitalizations. This shift has clear implications for growth investors.  Investors who index their growth exposures typically use market cap-weighted strategies, which by default leave these investors with heavy exposures to the mega-cap names that have been most challenged recently. In contrast, active managers, even within the large-cap segment, tend to have lower average market caps than traditional indexes, and those managers who use a highly active approach have the flexibility to respond to developing market trends, such as the emergence of smaller-cap growth.

Of course, fundamental analysis figures prominently in this process.  But for highly active managers, so can technical analysis, which enables a manager to identify and capitalize on changes in market sentiment, market momentum, the ratio of stock price advances versus declines, available funds, and trading volume.

In other words, technical analysis, while no guarantee of future results, can improve an active manager’s chances of spotting a stock just as it is starting to take off—or plummet. This tool can be of critical importance amid a changing market regime, like the one growth stocks may be experiencing now.

The bottom line is that an active approach to growth stocks can help investors avoid the potential pitfalls of indexing, especially an unwelcome overexposure to the mega-caps at the root of tech volatility today. Further, active managers can help investors gain exposure to the innovation that remains alive and well, but is often found in smaller-cap names and in other growth sectors beyond only tech names. This wider opportunity set can allow active managers to potentially identify more compelling near-term opportunities for above-market returns in growth equities.

 

1”FAANG” is a popular acronym grouping the large-cap technology companies Facebook, Apple, Amazon, Netflix, and the Google subsidiary of Alphabet Corp.

 

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The Lord Abbett Growth Leaders Fund Class A seeks to deliver long-term growth of capital by investing primarily in stocks of U.S. companies. Learn more.

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