Growth stocks are more sensitive to interest rates than value stocks. Higher rates devalue the long-dated earnings of fast-growing companies with pricey shares.
You’ve probably heard this narrative before. It trended heavily in 2022, a year in which Morningstar growth indices—tracking both U.S. and global equities—fell roughly 30 per cent, while the Fed and other central banks jacked up rates to combat persistent inflation. Meanwhile, shares of more modestly priced, slower-growing companies lost just 7 per cent less last year in aggregate. Fans of the ‘value factor,’ the notion that less popular stocks ultimately outperform, heralded a long-awaited change in market leadership.
If you’ve heard less about growth stocks’ sensitivity to rates in 2023, it’s because the growth section of the market bounced back, even as rates in the U.S. and other markets continued their upward march. Many prominent growth stocks rode a wave of enthusiasm for artificial intelligence, at least until the market cooled in the third quarter. Value sectors, like financial services, have lagged, though banks are said to benefit from higher rates.
Clearly, investing isn’t governed by anything like the immutable laws of physics. The forces that move markets, the relationships between assets, and the impact of macro factors are only obvious in retrospect.
Rates & Growth Stocks – A Complicated Relationship
You don’t have to scour the annals of history too deeply to find examples of growth stocks outperforming amid rising interest rates. Between 2015 and 2018, the U.S. Federal Reserve hiked by a total of 2.25 percentage points, in an effort to normalise after post-financial crisis monetary stimulus. What happened? Growth beat value over this stretch.
Those were the days of FANG—an acronym coined in 2013 for a small cohort of superstar growth stocks: Facebook, Amazon.com, Netflix, and Google. The digital transformations envisaged during the 1990s technology, media, and telecom bubbles were finally coming to fruition. Speaking of the age of ‘irrational exuberance,’ it persisted through three Fed rate hikes in 1999.
Value stocks, written off as ‘old economy’ in the dot com era but popular in the early 2000s, did enjoy a ‘Trump Bump’ after the 2016 election. The shares of economically sensitive, domestically-oriented companies in sectors like energy, materials, and financials soared in anticipation of policy changes. The technology sector, which Trump had disparaged, sank. But growth stocks came back into vogue as agenda items like infrastructure spending failed to advance.
Fast forward to 2023, and, despite several rate hikes, we’re once again talking about a small cohort of high-priced, fast-growing, ‘new economy’ stocks leading the market. The ‘Magnificent Seven,’ an expanded version of FANG that includes Nvidia, Microsoft, Tesla, Amazon.com, Meta (formerly Facebook), and Alphabet (formerly Google), is responsible for the lion’s share of the U.S. equity market’s gains this year. Many of these stocks are exposed to the theme that has consumed investors ever since the introduction of Chat GPT in November 2022: Artificial Intelligence.
