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Growth Stocks Setting the Pace for Global Equities

Harishankar Balkrishna, Investment Analyst in the Equity Division of T. Rowe Price

Executive Summary

  • Growth stocks have outperformed value stocks, driven by structural improvements in cash flow and earnings growth.
  • Equity valuations appear attractive on a medium‑term basis, but caution may be needed amid heightened near‑term volatility.
  • Global research platform can identify undiscovered growth stocks ripe for significant expansion.

Q. Global equity markets have bounced back strongly after a down year in 2018. What is your outlook on equities going forward?

We are still constructive on equities in the medium term. Currently, the S&P 500 Index’s forward PE multiple is just under 17, which translates into an earnings yield of about 6% and current dividend yield of nearly 2%.1 When you compare that against the backdrop of more than USD 15 trillion worth of negative‑yielding bonds in the global market, the equity market valuation looks rather attractive on a medium‑term basis versus other asset classes.2

There is a lot of bifurcation within the equity market, however. Growth stocks have meaningfully outperformed value stocks over the last decade, driven in large part by real cash flow growth and real earnings growth as opposed to valuation multiples rerating. Importantly, this is different from the dot‑com bubble, when valuations for growth stocks were coming just from multiples being rerated to reflect potential future earnings improvement.

Q. As you say, growth stocks have performed well in the past decade on the back of improving fundamentals. Do you think this is a structural change that will continue?

We do believe it is something that is quite structural. When you think about what is actually happening structurally within the growth segment of an index and the value segment, a lot of the growth stocks are actually disrupting the value stocks. Just look at a stock like Amazon disrupting traditional retail businesses or fintech disrupting banks to see how this is occurring today.

Over the last decade, Amazon’s total sales have grown more than eightfold.3 During that period, many retail stocks in the S&P 500 Index have actually had flat sales growth. To understand why Amazon performed so well as a stock, you have to look at how the operating performance of Amazon appears to have been much, much better than the average retail stock in the U.S. That is a structural change, and our view is that it is here to stay.

Having said that, growth stocks are often painted with just one brush, and that ignores the fact that there are also a lot of growth cyclicals in the market. Stocks in industrial automation and robotics that are linked to the industrial cycle, for example, have actually sold off meaningfully in the past year to the point where we see a lot of value.

It’s also worth noting that there are still several undiscovered growth stocks that, in our view, are ripe for significant expansion in the coming years. This includes stocks like e‑commerce providers Mercado Libre in Latin America and Sea in Asia and payment processer Stone in Brazil.

Q. The U.S.‑China trade dispute has had a major impact on financial markets across asset classes. What is your view on the situation, and how are you positioned for a potential outcome?

The U.S.‑China trade dispute has clearly had a significant impact on investor sentiment dating back to 2018. Where the situation goes from here in terms of getting to a resolution or whether there is further escalation really depends on politics and the rhetoric from both the U.S. and China. Initial negotiations on a trade resolution commenced some time ago, but there is a distinct possibility that we may not actually have a trade deal at the end of all these talks.

As investors, we do not want to position our portfolio for just one outcome in such a binary event because of the inherent uncertainty of the situation. Instead, we are staying true to our investment process and are investing in durable, quality growth stocks at a reasonable price. We do recognize that the trade dispute could increase volatility in the near term, however, and have lowered our portfolio beta.

Q. If we are to enter a world of heightened volatility amid rising geopolitical concerns and slowing global economic growth, what is your approach to managing risk in the portfolio?

We use beta as one key indicator when we look at risk and are quite dynamic about it when thinking about portfolio positioning. For instance, we reduced the portfolio beta in 2018, and that served us really well during the fourth quarter when the market sold off. At that point, we started to see more attractive valuations and dialed the risk back up again, which helped our performance through most of 2019 to date, particularly during the first quarter. We have since lowered the beta again because we believe the market may be too complacent regarding the risks of the trade dispute.

While we have scaled back some risk, we have also not gone overly defensive, as we still think equities represent good value over the medium term, especially versus other asset classes, in the context of trillions of dollars of bonds in negative‑yielding territory.

1 Source: Standard & Poor’s (see Additional Disclosures). Data as of September 25, 2019.

2Source: Bloomberg Index Services Limited (see Additional Disclosures). Data as of September 25, 2019.

3 Source: Bloomberg Index Services Limited (see Additional Disclosures). Data as of September 25, 2019.

 

Key Risks—The following risks are materially relevant to the strategy highlighted in this material:

Transactions in securities of foreign currencies may be subject to fluctuations of exchange rates which may affect the value of an investment. The fund is subject to the volatility inherent in equity investing, and its value may fluctuate more than a fund investing in income-oriented securities. The portfolio may include investments in the securities of companies listed on the stock exchanges of developing countries.

 

Additional Disclosures

Copyright © 2019, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Important Information

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

 

201911‑989782