Are Growth Stocks Set to Take Off?

25 January 2023 by National Bank Investments
Image of NBI Monthly Edition – February 2023

The soaring inflation and rising interest rates environment of 2022 battered growth stocks in particular. High-flying tech darlings experienced an especially hard landing. Could evidence indicating that inflation is on the wane signal a take-off for the sector?

Rate hikes stifle growth stocks

A year-end review shows that Interest rate hikes exerted downward pressure on growth stocks while value stocks mostly held their own.

Because of their often meager current cash flows, the price of growth stocks usually discounts earnings that the market anticipates will occur in the distant future. As a result, a parallel can be drawn to a certain extent with their performance and that of long bonds. They are therefore highly vulnerable to the interest-rate spikes that ordinarily accompany inflationary surges.

Graphic of the 2022 QQQ, VTV, and TLT ETF performance

Data in USD. Performance excluding distributions from January 1 to December 31, 2022. Source: MorningStar.
QQQ: Invesco QQQ Trust Nasdaq 100 Index ETF
VTV: Vanguard Value Index Fund ETF
TLT: iShares 20+ Year Treasury Bond ETF

The pricing power of value stocks

The pricing power they enjoy tends to favour value stocks in times of high inflation. 

They are generally able to maintain their profit margins despite the challenges posed by increasing input costs. Companies that boast a competitive advantage and a strong economic moat can keep pace with spiralling expenses by raising their own prices.

Would declining rates bolster growth stocks?

If rising interest rates hurt growth stocks, would a reversal benefit them?

While value stocks have historically outperformed them during inflationary periods, their potential to outpace a slow-moving macro environment typically gives growth companies the edge when central banks lower rates in response to economic contractions. 

Possible economic scenarios

Out of the three potential economic scenarios1 for the year ahead listed below, two favour growth stocks:

1. Peak inflation has been reached, and the economy escapes recession.

Inflation peaks and market rallies often go hand in hand. This scenario would likely spark a rebound for all sectors, but most markedly in the case of growth stocks.

Markets can bounce back swiftly. For instance, on November 10th, the Nasdaq 100 jumped 7% following the release of lower-than-expected monthly U.S. Consumer Price Index data.

2. Inflation has peaked, and the economy falls into a recession.

Still a relatively positive scenario for growth stocks. They would benefit from the declining interest rates and their resilient business models could prove salutary.

3. Inflation has not peaked, and central banks keep raising rates.

Hardly good news for anyone, but the risk-off sentiment it would stir could be most problematic for growth stocks.

Investors must be mindful that this does not constitute an outlier scenario. Despite tighter monetary policies, economies continue to grow, albeit at a slower pace, amid sustained demand and steady hiring. For the time being at least, inflation remains stubbornly above the stated 2% target range of most central banks. 

Graphic of the U.S. CPI vs. S&P 500

S&P 500 performance (including dividends) for the years following inflation spikes. Source: MorningStar
Consumer price index (CPI) data from the U.S. Bureau of Labor Statistics. Average year-over-year increases.

1 Source:

Growth at a reasonable price

Not all growth stocks are created equal, however. In the long run, financial markets reward earnings and, most notably, earnings growth over time. Finding value in growth stocks thus entails paying a reasonable price for the securities. 

As central banks aim to tame inflation without sending the economy into a deep recession, equity investors are grappling with their own balancing act. The final answer may lie in owning both growth and value stocks in their portfolios by adopting a strategy which combines the best of both worlds.

NBI equity funds

For investors whose interest has been sparked, here are some NBI equity funds that feature growth at a reasonable price (GAAP) strategies.

NBI Canadian Equity Growth Fund
NBI U.S. Equity Fund
NBI Active International Equity Fund

Legal notes

The information and opinions herein are provided for information purposes only and are subject to change without notice. The opinions are not intended as investment advice nor are they provided to promote any particular investments and should in no way form the basis for your investment decisions. National Bank Investments Inc. has taken the necessary measures to ensure the quality and accuracy of the information contained herein at the time of publication. It does not, however, guarantee that the information is accurate or complete, and this communication creates no legal or contractual obligation on the part of National Bank Investments Inc.

NBI Funds (the “Funds”) are offered by National Bank Investments Inc., a wholly owned subsidiary of National Bank of Canada. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus of the Funds before investing. The Funds’ securities are not insured by the Canada Deposit Insurance Corporation or by any other government deposit insurer. The Funds are not guaranteed, their values change frequently and past performance may not be repeated.

© 2023 National Bank Investments Inc. All rights reserved. Any reproduction, in whole or in part, is strictly prohibited without the prior written consent of National Bank Investments Inc.

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