This is going to be an interesting year with a wide range of scenarios, some of which are bound to much more discrete outcomes than markets tend to like such as the adoption and efficacy of Covid-19 vaccines. As we start the year many investors are primed for more monetary and fiscal bazookas and loading up on the reflation / inflation trade that should benefit cyclical sectors, small-caps, gold & precious metals, commodities and emerging markets. Price action and early inflation indicators are already spurring excitement and if maintained might lead to a further rotation away from secular, tech-enabled themes.
So what does this mean for growth stocks and the set-and-forget inclined investor?
In short, this might well become a challenging year for secular compounders, having run up substantially in terms of prices. Even on a growth-adjusted basis revenue and earnings multiple have reached high levels. Fundamentally, this is not necessarily unjustified. Valuations of long-duration growth stocks are very convex and sensitive to changes in growth and discount rate expectations.
However, that means that the tailwinds of historically low rates have to continue blowing. Hawking inflation indicators and the FED’s every movement could hence become the growth investor’s headache in 2021. An additional curve-ball will be the new Average Inflation Targeting Framework, which in the absence of historical heuristics is going to be a source of volatility.
Let’s acknowledge that a mean-reversion of rates poses material downside risks to price-levels of growth stocks, unless assertively offset by an extra shot of growth. But this would also materially affect highly levered sectors, small-caps, etc.
Can we counter the ‘one-trick pony’ argument?
To start with we aren’t quite convinced that the mean-reversion argument for rates (to 2-3%) makes sense as a central scenario against the backdrop of counter-inflationary undercurrents. The ever increasing adoption of technology is pushing out marginal costs and supply curves. We all consume more digital and physical goods and services (e.g. streaming, delivery, ride-hailing) that have not been drivers of inflation. Accelerating technology enablement of work (from home), health, education and housing could add runway to this secular trend. Moreover, demographic dynamics in particular the ageing of populations in DMs will further add to those counter-inflationary pressures.
This could set-up the conditions in 2021 for a goldilocks tightrope walk right down the middle between spiralling inflation and the next crisis. And growth stocks do particularly well in those phases of cautious optimism.
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Blackbird Capital 