Secular growth

An interesting finish to the week. The secular growth stocks did quite well today, noting this thematic basket of stocks comprises names that are expected to grow earnings largely independent of the economic cycle.

For example, think of the take-up of XRO’s software-as-a-service accounting products, or JHX, which is expected to take a larger and larger market share over time, regardless of how US housing starts fare. That’s what we mean by secular growth. Megaport, Altium, REA, ResMed, and Breville all fit that bill and feature prominently on Friday’s list of top performers.

The reason this is relevant is that the past week has been entirely about fears of slowing growth, possibly even a recession, as interest rates overtighten and energy price spikes negatively impact financial conditions. Consumer confidence has plunged accordingly.

That, as you might reasonably expect, could cause distress in over-geared, over-extended housing and related markets, which is why the banks, as a leveraged play on the macroeconomic cycle, have dropped the better part of 10% in a week.

Ergo, at the margin, investors today have been looking for names without overt macro risk, and stocks with lots of macro risk are doing poorly.

However, everything has macro risk; it’s just whether the correlation coefficient is positive or negative and whether the significance of the correlate sits on a measure like break-evens (the market’s expectations of inflation and stocks with a positive loading are considered as inflation hedges) or changes in real rates (as opposed to the level) or on some other factor that acts as a common proxy (e.g. commodity prices for growth, or credit spreads for risk).

The secular growth stocks, through the discount rate, are very exposed to rising rates, particularly those with the longest duration (XRO, despite being a great company, is not actually profitable. It could be if it so chose, but that’s not quite the point of the note, so we’ll let that go for now).

We think we are about half to two-thirds through the de-rating of secular growth stocks.

FPH falling back to a PE of 30x is still too expensive, as a general example, as these kinds of companies reprice due to higher inflation and higher interest rates and a broad reassessment of how fast and for how long those earnings can grow.

Before the Fed’s hawkish pivot, back in November 2021, the embedded earnings expectations in many of these names were wildly unrealistic and are now only merely highly optimistic.

It will be very interesting to see what Monday brings, depending on how tonight’s US CPI print goes.

(Update note: the Friday US CPI print was enormous, and I would expect with a high degree of certainty that Monday will bring considerable pain for the secular growth stocks, consumer stocks, tech stocks, and based on recent trading, the banks too).

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