What's on Your Mind? Yield Curve, Growth Equities, & AI Jobs
Brad Neuman, CFA;
Senior Vice PresidentDirector of Market Strategy
In this episode, Alger Director of Market Strategy addresses questions related to the yield curve inversion, growth being expensive, and job creation.
In this episode, Alger Director of Market Strategy addresses what the two- and ten-year yield curve inversion mean for growth equities, why wouldn’t someone stick with dividend-paying value equities and short-term fixed income if growth equities seem expensive, and what history tells us about job creation and destruction during industrial revolutions.
Brad Neuman: Hi. I’m Brad Neuman, director of market strategy, and today I’m answering the top questions submitted on behalf of investment professionals.
This is “What’s on Your Mind.”
First question we have reads, “What does the lasting two- and ten-year yield curve inversion mean for growth equities?”
So, the yield curve. Well, first off what it means is that the bond market is saying that short-term interest rates are not sustainable. They’ll be coming down over time. Now whether they come down simply because inflation is being reduced or real growth is coming down or whether there’s an outright recession is hard to say. But what we think it means is that nominal growth will be decelerating, and we think what that means for equities is that the companies with the most resilient fundamentals could outperform.
So, which are those companies? Well, we believe they’re growth equities, and that’s based on history. History tells us that growth stocks, their fundamentals may be much more resilient to economic downturns than value stocks.
For example, over the past three recessions, growth stock earnings have declined about a third as much as value stocks have. So, in our view, the inverted yield curve is showing signs that growth stocks could outperform value.
Next up we have a submission related to asset allocation. It reads, “I still think growth is expensive, especially with the recent runup in tech stocks. Why wouldn’t I stick with dividend value and short-term fixed income now that I get paid four to five percent?”
Well, first off, while there does appear to be value in the short end of the yield curve, I think it’s important to realize that those four to five percent yields that you’re seeing are somewhat of a mirage, in our view. We think the bond market is saying that those yields won’t stick around for very long. As far as why not stick with dividend value stocks, well, we think those stocks are going to be more cyclical, more impacted by the slowing economy, and growth stocks will be less impacted.
And in terms of valuation, while the yields look pretty fat on the fixed income side, if you actually look at the math of the sustainable fixed income, say a three and a half percent yield on a ten-year Treasury bond, that’s actually lower than the free cashflow yield of the Russell 1000 Growth, which is in excess of four percent, and the Russell 1000 Growth consensus estimates are for 14 percent annual growth over the next several years which, of course, Treasury bonds don’t have. The coupon is fixed. In fact, when we look at the data on valuation, small growth stocks look even cheaper.
In fact, if the historical relationship holds up, the small growth stocks trading at a large discount to the overall stock market when they typically trade at a premium, portend much higher returns, in our view.
And finally, we have a question related to the job market and innovation. This person asks, “Can you explain how, in all industrial revolutions, jobs are replaced with automation but tons more are created, including entire industries?”
Well, to answer that, let’s go with two examples in history, agriculture and transportation.
So back in 1900, we had about 11 million people working on the farms. That was 40 percent of all Americans employed. Today we have less than three million people working on farms, or about two percent of the total employed folks in America. However, we produce five times as many bushels of corn as we did in 1900. How could that be? Well, productivity. Tractors made farms more productive. The genetic engineering of crops led to higher yields.
But what happened to all those folks who were on the farm? Well, they moved to cities. They got more educated. They took jobs in factories, and they joined the industrial manufacturing revolution. Later on, they got even more educated. They got service jobs, and they climbed different rungs of the economic ladder, and that’s the lesson that history teaches us.
Similarly, around 1900 before the advent of the internal combustion engine, there were hundreds of thousands of workers employed as blacksmiths, carriages, harness workers, etc. Today those jobs are basically nonexistent. There’s less than 5,000 folks doing those jobs, but they were replaced by nearly a million auto mechanics, three-plus million professional truck drivers, and now that we’re staring autonomous driving in the face, those jobs could in turn be at risk. And what will replace those workers? Well, we’re already seeing reports of high-paying jobs being offered for those designing prompts for generative AI programs such as GPT-4.
That’s all we have time for, for this episode, but if you have pressing questions, please relay them to your Alger representative and we'll be sure to tackle them in future episodes. Thanks very much.