What Can Derail High Secular Growth Dominance? More Widespread Growth! by Robert McConnaughey, Columbia Threadneedle Investments
June 8, 2015
- The fundamental growth prospects for the growth industries that have led markets recently generally remain solid.
- If there is a kryptonite for secular growth leadership, it would appear to be a change in perceptions regarding global growth prospects.
- While we see room for sustained growth stories, we are preparing our strategic options for a potential new phase where different factor exposures may be needed to ensure success.
Year to date, U.S. equity markets have been led by a cohort of companies perceived to have the strongest secular growth. The Russell 1000 Growth Index had outperformed its value counterpart by approximately 5% through May. However, even within those broad indices, there was a narrower group of real leaders. Michael Goldstein of Empirical Research tracks a group of 75 “big growers,” the companies with the highest business growth characteristics and that grouping has outperformed the broader universe by 11% year to date. Our quantitative team’s analysis shows more granularly that the leading factor attributes this year have been the likes of long-term EPS growth, EPS revisions and sales growth. It might seem only natural that big growers beat the market, but that is not a constant state of affairs in the ebb and flow between growth and value leadership. So why has growth had the decided edge of late and, perhaps more importantly for us, can it persist?
We see three primary reasons why growth leaders have led the market.
- Scarce growth: In the absence of much global economic growth, those companies that are able to generate growth through innovation, developing new markets and continuously gaining market share stand out by contrast to the sluggish backdrop. We have advocated this “seek scarce growth” story consistently through the post-crisis recovery. The world is in desperate need of productivity growth, so we continue to see the vendors of productivity enhancement as extremely well positioned.
- Homogenous valuations: With the rising tide of global central bank easing lifting all boats, we can observe that valuation dispersions have been at extreme historical lows in the developed world, particularly when controlling for sector. Put simply, when all the merchandise is priced similarly, you might as well buy the highest quality goods. That appears to be a big driver of growth outperformance. If investors do not have to pay a significant premium for growth, why not seek it?
- Growth leadership has delivered the goods: While overall U.S. earnings growth has slowed, handicapped significantly by the decline in energy, some areas have continued to execute extremely well. Led by sectors such as biotechnology and software, the innovative corners of U.S. industry have delivered striking revenue and earnings growth. These are not the hollow concepts that epitomized the dot.com bubble excesses.
So, can this growth leadership persist? Valuations have become a little less homogenous, but the premiums paid for higher growth remain at or below longer term averages. The fundamental growth prospects for the growth industries that have led markets recently generally remain solid. If there is a kryptonite for secular growth leadership, it would appear to be a change in perceptions regarding global growth prospects. A pickup in global growth would likely drive a rebound in more cyclical sectors. Keep in mind that the world is awash in liquidity and seeking the next marginally higher returning asset. So a whiff of broad economic acceleration would likely drive a reversal into sectors such as energy, basic materials, and low-margin industrials where the potential operating leverage to a change in overall demand might be greatest. In aggregate, we do not yet see a clear delta in global growth prospects, but we are monitoring very carefully. We saw a especially strong U.S. jobs number on Friday, and given the magnitude of central bank actions taken and ongoing in the EU, Japan and China, there is certainly ample financial tinder for growth. While leading growth stocks would appear to continue to have fundamental runway in front of them, we are conscious that cyclicals may well have their day in the sun; we are monitoring for global growth green shoots accordingly. Energy is a particularly interesting example to watch, as the downturn is causing a dramatic restructuring of cost bases such that a recovery in demand would appear likely to generate significantly enhanced operating leverage for the more nimble operators.
Bottom line: While we continue to see room for sustained growth stories to thrive, we are preparing our strategic options for a potential new market phase where different factor exposures may be needed to ensure success.