Dan Chung: The Appeal of Growth Equities When Earnings Growth Moderates
May 29​​, 2019​​
Expectations for moderating earnings growth have contributed to bouts of market volatility even though many corporations are benefiting from unprecedented levels of innovation such as internet-related technologies. At Alger, we believe the positive performance of growth equities that has frequently occurred during past periods of weakening earnings growth can help investors keep market volatility in perspective and avoid making rash decisions such as panic selling. Perhaps more importantly, we believe investors should focus on the rapidly growing role of innovation that is supporting the fundamentals of high-quality companies and propelling the economy forward.

Keeping Earnings Growth in Perspective

According to FactSet Research, S&P 500 earnings growth was negative during the first quarter of 2019 year over year and is expected to hit only 3% to 4% for the full year. In comparison, earnings growth last year exceeded 20%. A look at equity markets during the past 35 years shows that growth equities have responded favorably to weakening earnings growth. From 1984 to 2018, eight such periods occurred during which the Russell 1000 Growth Index generated a median return of 15.8% compared to the 14.1% return of the Russell 1000 Value Index1. We believe this outperformance resulted from the less cyclical nature of growth equities and the tendency for value stocks to have more operational and financial leverage. During such periods, strong growth among corporations is scarce, which further enhances the appeal of growth equities.

We believe that a historical perspective clearly shows that growth equities have potential to generate additional gains even as earnings growth moderates. An important trend of unprecedented levels of innovation, including the ongoing digital revolution and breakthroughs in health care, are allowing leading companies to disrupt their respective industries and legacy business practices while helping to sustain economic growth. Online retailers are aggressively taking market share from brick and mortar stores and digital platforms, such as Google and Facebook, are increasingly capturing advertising revenues previously spent on legacy media; robotics are helping to automate manufacturing; and artificial intelligence and machine learning is increasingly being adopted across industries. In the Health Care industry immunotherapy is helping to treat cancer, genetics are allowing doctors to select the best medical treatments on a patient-by-patient basis, and new products, such as insulin management devices for diabetics and miniature heart pumps, are rapidly transforming medical care.

We believe data points to the economic recovery having potential to march onward and that a period of economic contraction is unlikely in the foreseeable future. In just one example, the Leading Economic Index is up 3% year over year as of April. From an historical view, the last seven recessions haven’t occurred until the index has declined, on average, 3.5%.

At Alger, we will continue to seek attractive investments being created by innovative companies while embracing a historical view of equity markets, including during times of moderating earnings growth. In closing, we urge investors to embrace change and opportunities being created by innovative companies.​​​
​​​​Source: Bank of America Merrill Lynch Quantitative Strategy. Median data for periods: June 1984-December 1985, June 1988-December 1991, March 1995-September 1998, March 2000-December 2001, December 2003-June 2005, March 2006-March 2009, June 2010-September 2012, and December 2013-December 2015.

Fred Alger & Company, Incorporated is the parent company of Fred Alger Management, Inc. The views expressed are the views of Fred Alger Management, Inc. as of May 2019. These views are subject to change at any time and should not be interpreted as a guarantee of the future performance of the markets, any security or any strategies managed by Fred Alger Management, Inc. These views should not be considered a recommendation to purchase or sell securities. Individual securities or industries/sectors mentioned, if any, should be considered in the context of an overall portfolio and therefore reference to them should not be construed as a recommendation or offer to purchase or sell securities.

S&P 500 Index: An index of large company stocks considered to be representative of the U.S. stock market. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher growth earning potential as defined by Russell's leading style methodology. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. Russell 1000 Value Index: An index that measures the performance of those Russell 1000 companies with lower price/book ratios and lower forecasted growth values.
Facebook and Google holding company Alphabet represented 2.04% and 4.12% of Alger assets under management as of Feb. 28, 2019.
Risk Disclosure: Investing in the stock market involves risks, and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as their prices tend to be higher in relation to their companies’ earnings and may be more sensitive to market, political, and economic developments. Technology and healthcare companies may be significantly affected by competition, innovation, regulation, and product obsolescence, and may be more volatile than the securities of other companies.

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