After a meteoric rise for the last several years, growth stocks took a steep tumble last year; while large-growth companies stayed strong for several months beyond their small-growth counterparts, which fell 35.7% through September 2022, they eventually saw their fortunes fall as well, dropping 39.4% for the same period. In contrast, value stocks stayed steady and grew in popularity, reports an article in Morningstar.
Many saw the writing on the wall; analysts were calling out the U.S. stock market for being widely overvalued and predicted growth stocks’ downfall early this year. But they didn’t foresee the rampant inflation and the Fed’s rapid interest rate hikes that followed. Now, economic research organization The Conference Board pegs the chance of a U.S. recession in the next year at 96%, wiping out the forecasts such as Morningstar’s Dave Sekera, who wrote in January: “Although the [U.S. stock] market is broadly overvalued, we see upside opportunity for investors in the value category and small-cap stocks, both of which should benefit from continued economic prosperity.”
But inflation doesn’t impact corporate profits that strongly, because companies usually raise their own prices in order to keep up with rising costs. It does, however, impact growth stocks—both negatively and positively. The negative impact comes from the interest rate hikes; since growth stocks are generally valuable for their future earnings and not their present cash flows, they can be susceptible higher interest rates. The positive impact comes as a result of the overall economy shrinking; if expansion bolsters value stocks, then the opposite is likely true, and contraction will boost growth stocks. In other words, less is more, for growth stocks, the article contends.
In three possible scenarios for 2023, Morningstar portends, two of which could benefit growth stocks. First, if inflation has already peaked and the economy squeaks through without going into a recession, growth stocks would probably rebound and earn back much of what they lost as the Fed begins to lower interest rates. In the second scenario, inflation has also already peaked, but the economy doesn’t escape a recession. That would be a more difficult situation, but growth stocks would probably perform well, benefiting from lowered interest rates and the dependability of their operations. The last scenario, the most dire, is where inflation hasn’t peaked yet, and the Fed continues to hike up rates. That would pummel growth stocks, whether or not a recession occurs.
It’s always possible that none of these scenarios will take place, but looking ahead may “offer some clues about what the next year might bring,” the article concludes.