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Market View

The resumption of growth market leadership may confound some investors, but there are good reasons for it.

 

In Brief:

  • Growth stocks continue to benefit from a high rate of technological innovation despite slowing global economic growth.
  • Smaller, rapidly growing companies are often the most innovative, but are difficult for investors to access using a traditional market cap-weighted index.
  • Investors should note that a high-growth investment approach is not only attractive in today’s market but, historically, has tended to outperform over the long run as well.

 

Following a tumultuous fourth quarter of 2018, growth stocks are once again outperforming value stocks year to date (as of February 15, 2019)—essentially picking up where they left off in September 2018 before a volatile fourth quarter interrupted a 21-month winning streak.

Year to date (as of February 14, 2019), growth stocks (as measured by the Russell 3000® Growth Index) have outperformed value stocks (as measured by the Russell 3000® Value Index) by more than 2%. This follows on the heels of a dramatic run of growth outperformance from the start of 2017 through the third quarter of 2018 when growth stocks outperformed value stocks by more than 32% on a cumulative basis.

The resumption of growth market leadership may confound some investors who believed that the fourth quarter pullback portended an end to growth’s strong run, but looking under the surface we can identify a number of factors behind its continuation in today’s market environment.

Technological Innovation Driving Growth
The rate of technological innovation over the past decades has been remarkable, yet the innovation boom may very well only be in the early innings. With a long runway potentially still ahead, the acceleration of technological innovation has provided a tailwind to traditional growth sectors like health care, consumer discretionary, and technology with biotech, e-commerce, and cloud-computing companies within these sectors disrupting the status quo.

Secular Growth Outpacing the Broader Economy
While we continue to see expansion in both global economies1 (as measured by gross domestic products) and corporate earnings,2 neither are growing as fast as they did during their peaks in 2017 and 2018, respectively. In a slowing global economic environment like this, companies with strong secular growth prospects (those with earnings and revenue growth tailwinds independent from the broader economy) appear relatively more attractive to investors.

Strong U.S. Dollar Compounding the Issue
Compounding matters for many large multinational companies is that, in addition to decelerating earnings growth, a strengthening U.S. dollar over the past year has cut into year-over-year growth, which boosts the appeal of companies able to accelerate their growth in the face of economic and currency headwinds.

Given the prevailing market backdrop and the potential runway ahead for innovative companies, we believe the best way for investors to gain exposure to a resumption and potential continuation of growth outperformance is likely through an allocation to true high-growth companies. However, isolating exposure to true high-growth companies is easier said than done, as demonstrated by a common proxy for growth: the Russell 1000® Growth Index.

As Table 1 indicates, the top of this predominant growth index is filled with many slow-growth, dividend-paying companies, which may disappoint investors who are seeking exposure to fast-growing, innovative companies. In addition, traditional market cap-weighted index approaches, or large managers who by a function of their size may have to act in an index-like manner, have exposures that are tilted toward the largest companies in their investment universes, overlooking smaller, rapidly growing companies who are often the most innovative (to say nothing of the headwind that U.S. dollar strength presents to large multinational companies today).

Active managers working outside a cap-weighted agenda can help investors circumvent these issues. 

 

Table 1.  Many Companies in the Top 20 of the Russell 1000 Growth Index are Slow Growth and High Yielding
(As of December 31, 2018)

Source: FactSet.
Top 20 companies in the Russell 1000 Growth Index, by market capitalization. *Historical 3-Year Sales Growth data as of 12/31/2018. **Alphabet, Inc. Class A and Class C share holdings have been combined. Price to earnings FY1 ratio shown is an average of the two share classes.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. The securities and data are for information only. It does not constitute a recommendation or an offer for a particular security, nor should it be taken as a solicitation or recommendation to buy or sell securities or other investments, and should not be used as the basis for any investment decision. Due to market volatility, the market may not perform in a similar manner in the future.

 

In addition, while we have emphasized that true high-growth companies may be particularly attractive in today’s market, investors should note that a high-growth investment approach historically has tended to outperform over the long-run as well (see Table 2).

 

Table 2. Historically, High-Growth Companies Have Been Worth Their Premium
Three-year rolling averages (December 31, 2008–December 31, 2017)

Source: FactSet and Lord Abbett Research. 
Based on annual reported earnings. Most recent data available.
The average top 10% of high-revenue-growth stocks were  chosen by screening all companies with a market capitalization greater than $10 billion at the end of each three-year time period and then stacking the companies according to their revenue growth over that three-year time period.
Past performance is not a reliable indicator or guarantee of future results.

 

Of course, as is often the case with fast-growing, market disrupting companies, volatility is not uncommon—–which is why investors may want to consider a highly active, professionally managed approach to navigating this dynamic market segment.

 

1 International Monetary Fund.
2 FactSet.

 

A Note about Risk:  The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

Glossary of Terms

The price/earnings ratio (PE) is the ratio of a company's stock price to the company's earnings per share. The ratio is used in valuing companies.

The Russell 3000® Growth Index measures the performance of those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 3000® Value Index measures the performance of those Russell 3000 Index companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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