A Pro-Growth Move

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Originally posted at Briefing.com

When President Trump was elected last November, the stock market threw a pro-growth party that resulted in a robust year-end rally for the major indices. Stock market participants were enthused by the prospect of reduced regulations, increased infrastructure spending, the repeal and replacement of the Affordable Care Act (aka Obamacare), and, most importantly, tax reform.

That enthusiasm manifested itself in the outperformance of value stocks, but in more recent months, growth stocks have flexed their muscle and have been leading the major indices to new record highs.

The shift in leadership has been plain to see and it plainly suggests that the stock market isn't as hopeful as it once was that the assumed pro-growth legislation will come to pass.

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That has been discouraging in an economic sense because the real-time economic data have served as a reminder that the US economy is still stuck in its low-growth rut.

Low growth, however, means low-interest rates, and that combination typically means good things for growth stocks. Paradoxically, then, the risk for growth stocks is growth picking up.

A Narrative

If a picture is worth a thousand words, the picture below says them all with respect to the stock market's economic outlook following the election.

Growth vs Value

Notice the jump in the value indexes after election day and their outperformance vis-a-vis the growth indexes.

An important point to make in looking at the chart above is that the growth indexes weren't weak after the election. All boats rose with the post-election tide, but clearly, value outperformed growth into year-end and in the early part of 2017 when growth expectations were at an escape-velocity pitch.

In late January, however, there was a trend shift. Since then, the growth indexes have risen appreciably while the value indexes have moved mostly sideways (befitting an economy and a Congress that have done much the same).

Growth vs Value YTD

Plenty of readers will be quick to cite the dysfunction in Washington as the catalyst for the shift. It's a fair criticism from the basic standpoint that the pro-growth item the stock market wants the most — the passage of tax reform — has been called into question by the inability of the GOP-controlled Congress to get a health care reform bill passed.

The political travails associated with health care reform, President Trump's firing of former FBI Director Comey, and the special counsel's investigation into Russia's interference in the 2016 election have dominated the political narrative.

There is more to the stock market narrative, though than just politics.

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One could argue that worries about the Fed making a policy mistake by tightening too much, too soon, have also been a contributing factor to the renewed leadership of the growth stocks.

Falling oil prices, a flattening yield curve, a paltry 1.4% annualized growth rate for first quarter GDP, string of weaker than expected data that has triggered a host of downward revisions for Q2 GDP, a suffering dollar, weak wage growth, and downward-trending inflation rates are all in the mix as drivers for the outperformance of the growth stocks since the lot of them aren't painting an encouraging growth picture.

Citi Surprise

In the Know

To be fair, it isn't all bad. The one thing that matters most for the stock market — earnings growth — has been quite good. Herein lies the best defense for why the major indices are at record highs while the spirit of compromise in Washington seems to be at a record low.

A large chunk of corporate America is doing just fine without any fiscal stimulus, although market participants appreciate the point that corporate America could be doing even better with tax reform.

Alas, tax reform is still more hype than substance. That could change in the coming months if Congressional leaders are to be believed, yet market participants can't take anything for granted knowing that the GOP-controlled Congress has failed to get health care reform done.

So, in the absence of a political catalyst for stronger growth, market participants have gone with what they know.

They know that growth stocks tend to exhibit relative strength in an environment where economic growth is low and interest rates are, too; and they know growth stocks do even better when they deliver big sales and earnings growth to back up their premium valuations and growth-stock profile.

What It All Means

The contribution of the growth stocks carried the Nasdaq Composite to ten consecutive winning sessions — its longest winning streak in more than two years — and a new record high. It also carried the S&P 500 information technology sector to a new high, eclipsing the former high water mark reached in the dot-com bubble days.

The performance of the growth stocks of late has been captivating and laudable. They seem to go up each day, but if they go down, they don't stay down for long.

Once again, there is a feeling of invincibility surrounding the growth stocks, and particularly the mega-cap growth stocks, as disappointing political developments and negative economic surprises have led market participants to think the low-growth economic mode will persist, which is a positive consideration for growth companies delivering sales and earnings growth in excess of the industry/market average.

That feeling of invincibility was palpable in the past week as some of the large-cap growth stocks were moving like small-cap stocks with low floats and the TINA (There Is No Alternative) perspective was back en vogue.

It is often said that stocks can stay overbought for an extended period of time, but when a feeling of invincibility is palpable is often the time when a short-term rally loses some steam.

We don't know what the future holds. The past and the present have provided some nice gains for growth stocks, because, well, growth has been lacking and interest rates have remained low.

If that dynamic changes for whatever reason — maybe even because a tax reform plan is passed — growth stocks could find themselves subject to some money flow disruption as the value stocks return to favor. To that end, stronger growth should presumably invite higher rates that will make it more challenging for growth stocks to achieve multiple expansion.

That doesn't mean growth stocks will be outright weak, yet they could be relatively weak vis-a-vis the value stocks like they were in the immediate wake of election day.

Growth stocks are hot right now, though, because the market's perspective about economic growth and the pace of rate hikes has cooled off again. If that perspective changes, the performance of the value stocks should be telling.

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About Patrick O'Hare

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