Seeking to Add Growth to Portfolios
What happened last week?
The S&P 500 was little changed after a flurry of earnings reports revealed the nation's biggest banks were in better shape than some had feared. Smaller banks saw their deposits stabilize but leading economic indicators pointed to a softer economy ahead.
- The S&P 500 decreased -0.10%
- The Dow Jones shed -0.23%
- The Nasdaq composite decreased -0.42%
The market's swings could be larger this week with 180 S&P 500 companies reporting their Q1 results, including some important Tech names, and 14 Dow Jones stocks in the mix.
The market expects the Fed to raise rates one last time by 0.25% on May 3rd.
3 Things to Know
Growth investing sees a burst of optimism
While both cash-generating and money-losing tech have rebounded during this period, the bounce in the most beaten-down stocks has been appropriately underwhelming.
In fact, there is a clear lack of “market breadth” within the Nasdaq index with the larger, stronger and more well capitalized companies driving much of its gains. If this were the true beginning of an early cycle recovery, we would expect the bear market’s worst victims (i.e., unprofitable tech) to be the best performers.
In contrast, with the Fed still focused on fighting inflation and reducing its balance sheet, funding will be both scarce and more expensive for firms that lack a near-term profit trajectory.
There is no doubt that some loss-making firms with transformative technologies will be the positive “wish I had invested then” headlines of tomorrow. Good ideas and strong management teams are likely to receive continued investment and show grit and persistence.
We doubt, however, that such returns will be earned in the short term. Survival will be in question for many of the experimental firms born in the Fed-driven easy money era.
‘Responsible growth investing’ for the next cycle
We do not expect growth investing to mimic the euphoric markets of 2020 and 2021.
The times of indiscriminate outperformance for shares, coins or NFTs that don’t have sustainable value trajectories is over. But we do believe that with a higher level of discipline, growth investing will become one of the best ways to generate above-average returns in the next business cycle.
What does this mean for investors?
Our framework for identifying compelling, potential high-growth opportunities incorporates the following considerations.
- Think thematically: Identify sectors and themes with high total addressable market and relatively low penetration today. We must look to the next generation of technological advancement, in areas like AI, robotics, and cutting-edge computing as better avenues for identifying market-beating companies over the next decade.
- Quality matters when money isn’t free: Find companies with a strong position within these industries and, particularly in the current environment, an ability to self-finance future growth. This suggests a bias toward larger, profitable firms over smaller upstarts.
- Growth at a Reasonable Price, or GARP, over pure growth: Consider valuation in conjunction with a firm’s expected growth rate. This strategy has historically outperformed both pure growth and value investing, as it weeds out both overvalued growth stocks as well as value stocks in secular decline.
Bullish on AI
ChatGPT and similar programs are what’s known as Generative AI. Whereas previously AI could read and write, now it can understand and create content. The technology is not connected to the internet but uses billions of data inputs to formulate content.
Generative AI has been used for some time. However, the release of ChatGPT has taken the technology and its use cases to the next level, capable of creating entirely new “copy” and content.
PwC estimates that AI could contribute up to $15.7 trillion to the global economy by 2030.
A large chunk of this is estimated to come from productivity gains ($6.6 trillion), ranging from educators grading exams to software developers writing or debugging code, job seekers creating resumes, or helping online content providers sell and advertise products and services.
We see companies that can provide the computing power and infrastructure to accommodate the growth in AI as major potential growth opportunities. These include hardware manufacturers of the most advanced semiconductors and cloud players on the infrastructure side.
Other enablers and adopters of generative AI that form part of the ecosystem also stand to benefit.
See our weekly CIO Strategy Bulletin for more details