26 BARRON’S August 5, 2019
Funds
Rate Cut Means Good News for Growth Stocks
ByLeslieP.Norton
THE FEDERAL RESERVE JUST JANGLED THE
nervesofmanyvaluemanagerswhohave
been soothing themselves with the com-
forting notion of reversion to the mean.
Valuestocks—thosetradingatcheaper-
than-average price/earnings ratios and
other valuation metrics—have historically
outperformed growth stocks, shares of companies with
higher-than-averagerevenueand,forthosethatareprofit-
able, earnings growth. But as growth stocks are about to
notchtheireighthyearofbeatingvalueinthepast11years,
manyinvestorsarewonderingwhenvaluemighthaveitsday.
Not soon. The Fed just cut interest rates for the first
time in a decade in a bid to counter uncertainties about
global growth and the persistent undershoot in inflation,
settingthestageforgrowthstockstoshineandpotentially
slowingdownvalue-orientedsectorssuchasfinancialsand
utilities.Andmanyeconomistsandmoneymanagersareex-
pecting more cuts to come: After the Fed rate cut, MFS
strategist Rob Almeida suggested that zero rates weren’t
outofthequestion.“Inanenvironmentwhereratesindeed
go lower, growth stocks are just mathematically worth
more,”hetells Barron’s .“Sotheterminalvalueforagrowth
companyishigher,becauseofthediscount
rate, than it is for a cyclical company.”
P/Eratiosforgrowthstockshavewid-
enedsignificantlyovermultiplesforvalue
stocks,observesBespokeInvestmentGroup.Yetvaluations
aregenerallymorepalatablethanthey’vebeeninthepast—
say,duringthetechbubble.That’sbecauseoutperformance
is driven by both stronger earnings and higher multiples.
In history, the tech bubble of 2000 looms large. At the
time, many popular companies had no earnings. Partly as a
result,thetrailingP/Eratioforgrowthstockswasmorethan
30 times greater that for value stocks. “Today, that number
iscertainlyelevatedat10times,butisatinyshadowofwhere
it was during the tech bubble,” Bespoke observes. That
makes outperformance look more sustainable.
Complicatingtheargumentisthetremendousdisruption
goingoninbusinessestoday.“Thistimearound,we’reseeing
far more fundamentally based real earnings growth,” says
DanDavidowitz,managerofthe PolenGrowth fund(ticker:
POLRX).“Thismaygoonforalongerperiodoftimebecause
there really is growth there and it looks persistent.”
Sowhat’saninvestortodo? “Lookatcompanieswith
wide-opengrowthpotentialandnorealcompetitivethreat,”
says Davidowitz. For instance: Alphabet (GOOGL), where
“there’sstillatremendousamountofofflineadvertisingmov-
ing online,” benefiting properties like Google search, You-
Tube,andGoogle’scloudbusiness.Anothersuchcompanyis
Adobe (ADBE),whichbenefitsfroma“monopolyinthecore
digital-mediabusiness”atatimewhentheworldisscarfing
up digital content. For both Alphabet and Adobe, “we see
persistentandabove-averagegrowthfordecades,”hesays.
Another skilled growth investor, Jim Callinan of Oster-
weis Emerging Opportunity (OSTGX), has been nibbling
atnameshelikesthathedeems“reasonablypriced,”includ-
ingfinancialcompaniesbenefitingheavilyfromtechnological
innovation.Oneis EnovaInternational (ENVA),theonline-
onlyinstallment-loanandcredit-cardbusiness.Thecompany
recentlybeatearningsandrevenueforecasts.“Fallingrates
make financing costs really attractive,” Callinan says. An-
other is Meta Financial Group (CASH), which does pro-
cessinganddepositsforgiftcardsandpayrollcards.It’snow
buying consumer and commercial loans.
Andrew Acheson of Pioneer Fundamental Growth
(PIGFX) said he has been concerned about frothy valua-
tions,sohe’sfocusingonidentifyinggrowthstocksthatare
highly correlated to value stocks but are not value stocks.
Hethinksthesearemorelikelytoholdupifandwhenhigh-
valuegrowthstocksgetcrushed.Achesondeclinedtopro-
vide specific names, citing company policy.
Whatmightactuallycatalyze avaluerevival?ChrisSen-
yek, chief investment strategist at Wolfe Research, wrote
lastweekthatmanyinvestorswonderifvaluewilleverout-
perform growth “on a sustained basis again.” Senyek out-
linedthreeconditionsforavaluerevival.Oneisatradedeal
betweentheU.S.andChina,whichprobablywouldleadto
risingratesandhighercommodityprices.Thatwouldmean
goodthingsforvalue,whichisheavilyweightedtowardfi-
nancials,energy,andmaterials.Meanwhile,growthindexes
would lag behind as people rotated out of tech, where the
momentum trade has excelled, Senyek wrote.
Two,ifcentralbanksdisappointinvestorsawaitingmore
easing, value could outperform, as it does when P/Es are
contracting. “As long as equity markets are being pushed
higherbyrisingmultiplesonthebackofcentral-bankeas-
ing expectations,” wrote Senyek, growth will beat value.
Finally, the momentum trade could fade. For the past
2½ years, says Senyek, the biggest contributors to the
Russell 1000 indexhave been large-cap stocks with strong
price momentum, which are big components of the growth
index. Now, he says, “The momentum trade appears very
stretched.”
Onemanageris
lookingforgrowth
stocksthatare
highlycorrelated
tovaluestocks.
CashTrack,
pageM24