Hello, I’m Alex Bernstein and you’re listening to The Alger Podcast, Investing in Growth and Change. After six months of fairly intensive market churning, investors may be asking what happened to growth stocks? and what might I expect for growth stocks during the second half of this year? Here to explore some of those questions is Alger Vice President and Product Specialist for the Investment Research team, Art Nowak. Art, thanks so much for joining me on the podcast today.
ARTHUR NOWAK: Thank you for having me on, Alex. I appreciate the opportunity.
ALEX: So, Art, how would you sum up what happened in the markets for the first half of the year? And why was growth investing hit so hard?
ART: So, before January of last year, we were in a decades plus long secular bull market driven by innovation and growth stocks. In fact, from the end of the global financial crisis in 2008 to the beginning of last year, the S&P 500 growth outperformed the S&P value by an average about 500 basis points a year. So, this was a bull market that was driven by a growth investment.
However last year, we believe there were two distinct rotations out of growth into value. The first really was at the beginning of the year. Everybody thought we were going to have this grand reopening before omicron hit. So, people were buying a lot of the areas that had been hit hardest during the pandemic. So, they were focused on bidding up airline stocks and cruise stocks and kind of avoiding the AI companies and the cloud computing stocks of the world, where we invest in general at Alger.
And then the second rotation was in November when inflation fears started to come about, and The Fed started to talk about having to raise interest rates to curb inflation. And so, this led to a selloff on long duration assets, stocks that we believe are going to be growing over the next ten years. People exited those and more cyclical, value-oriented stocks that paid cash out to investors in dividends and buybacks became in favor.
But at Alger, we expect growth companies to retake the mantle from their value counterparts in the future. I think that the growth companies that we invest in are still fundamentally sound companies. But we’re going to go through times where our investment style is out of favor. And this just happens to be one of those times.
ALEX: Art, one of the primary concerns today for investors is the current rising rate environment. How concerned are you with the Fed’s actions regarding interest rates?
ART: So, we’re really not concerned about interest rates rising, mainly because when interest rises generally the economic growth slows. And that’s in general, a boon for growth- oriented stocks, because these companies can create their own growth while value companies and cyclicals depend on a rapidly growing overall economy, and they tend to struggle when GDP slows down.
In fact, we looked at the last four tightening cycles and what we think happens is value stocks take over in the six months before and the three months after the first-rate hike. But after that nine-month period, growth stocks tend to take over the mantle and outperform. And we’re definitely seeing some significant dislocation in the valuations and some of the areas of the market, specifically mid-cap growth and small-cap growth.
ALEX: And when you say dislocation, what do you mean exactly?
ART: I think the simplest way to put it is that we believe the prices in areas like mid and small-cap growth aren’t reflecting the fundamentals of the stocks that we’re investing in. I think a good example of that would be the S&P 400 mid-cap growth benchmark.
Today, the S&P 400 mid-cap growth, it’s trading probably about 40 percent lower than it has over the last 20 years. So, what we’ve really seen in mid and small-cap stocks is that the price in that PE equation has dropped significantly over the short term, while the earnings of these companies, they’ve stayed steady and, in some cases, grown.
So, that really leads us to believe that a lot of these stocks are deeply undervalued, especially when compared to their large-cap brethren. And we think this could be a coiled spring for these growth stocks moving forward. I said that the last time we saw these types of deep discounts in valuations was about 20 years ago, and that was right after the dot com fiasco in the early 2000’s. From 2002 to 2005, after that bubble burst, mid-cap growth stocks outperformed the S&P 500 by almost 500 basis points a year.
ALEX: Is this the first time, historically, you’ve seen growth companies at such a deep discount?
ART: It isn’t the first time, but the last time was a long time ago. Like I’ve said, we’ve seen a pretty good bull run driven by growth stocks. So, we haven’t seen these valuations in a long time.
ALEX: How long do you expect this opportunity to last?
ART: So, the first-rate hike this year was in mid-March, so we’re fast approaching the end of that three months after the first-rate hike. So, if history repeats itself, we could see that discount start to tighten in the near future.
We’re also seeing some other tailwinds in the market as companies start to rebuild inventories. We're seeing China loosen some of their COVID lockdowns, which should help ease supply chains. So, we think we’re definitely seeing some tailwinds for innovative growth stocks. And we’re hoping that these deep valuation discounts that we’re seeing start to close sooner rather than later. So, I think once the tide changes and we switch back to a growth regime, that gap will tighten pretty quickly.
ALEX: Art, I know, in this market environment, one of the asset classes that you’re particularly excited about is mid-cap, and in terms of products, Alger’s Mid Cap 40 ETF. Why mid caps and why mid-cap ETF, right now?
ART: So, we like mid-caps because we believe they’re passed the stages of infancy that small-caps have to fight through. And in general, we think they’re overlooked and underutilized by investors and analysts alike.
So that’s kind of why mid-cap right now. And why I think the Alger Mid-cap 40 ETF? The Alger Mid-cap 40 ETF, it’s an actively managed semitransparent ETF managed by Amy Zhang. It’s focused, concentrated, it has a high active share, so it’s not a benchmark hugger. Usually when people think ETFs, they think passive. This is not that. And so, it’s a portfolio of the 40 highest conviction names Amy finds in the mid-cap space.
At Alger, we invest in exceptional growth companies undergoing positive dynamic change and we think our competitive edge is identifying those companies and capitalizing on the change before it is recognized by the market, and so stock selection is really our forte. We’re benchmark agnostic, we focus on in-depth, fundamental, bottom-up research and try to develop a differentiated view. So, like I said, we’ve seen the same valuation compression in this portfolio that we’ve seen in the U.S. benchmarks. So, we do think there might be great opportunity for growth going forward with the Alger Mid-cap 40 ETF and the ticker on that is FRTY.
ALEX: You mention Amy Zhang, the portfolio manager on Mid Cap 40 ETF. And by the way, if investors would like to hear directly from Amy about this ETF product, we had her on the podcast last time, and her insights into this market were very interesting. Anyway, I wanted to ask you, Art, how do you think Amy handles volatility?
ART: Absolutely. One of my favorite quotes from Amy is that knowledge reduces risk. And she has a team of seven analysts. And so once we invest in a company, we don’t just let it sit. We’re constantly doing channel checks, we’re constantly reaching out to competitor CEOs to see if the moat that we think we have in a company is closing. We talk to the customers for the companies that we invest in to make sure that the products are staying in line, with what we expect from them. And so, we make sure that we know our companies that we invest in exceedingly well. So that is kind of on a qualitative basis how Amy thinks of risk. She thinks that knowing the companies better than the street gives us a leg up in terms of any deteriorating fundamentals within the companies we invest in.
And on a quantitative basis, Amy gets reports from our director of Quant and Risk Management on a monthly basis which shows kind of macro risks that we have within the portfolio. It shows areas where we might be overexposed, and it shows factor exposure. So, we can really keep an eye on the overall portfolio on a quantitative basis and make sure that we’re keeping an eye on areas of risk within the portfolio.
ALEX: Art, thanks so much for talking with me this afternoon.
ART: Thanks Alex, really appreciate you having me on today.
ALEX: And thank you for listening. For more information on Alger Mid Cap 40 ETF, other Alger ETF products, and of course, our latest insights, please visit www.alger.com.
