The share market behaves pretty strangely sometimes.
For most of this year, growth stocks have been punished out of the fear of rising interest rates.
But now that Australia and the rest of the developed world are actually in the midst of a multi-month rate-hike cycle, growth shares are rocketing upward.
The global bellwether for growth stocks, the Nasdaq Composite (NASDAQ: .IXIC) index, has risen 7% over the past fortnight. It even rose 4% on Thursday morning after the US added another 75 basis points to its benchmark interest rate.
So what does this mean?
Investors are always told markets are forward-looking. Does this mean it has moved past bearishness for growth stocks? Is it recovery time now?
Wilsons head of investment strategy David Cassidy this week attempted to answer this conundrum.
'Slower growth should favour the growth style'
With interest rates heading upwards around the globe, an economic downturn is sure to follow.
And, according to Cassidy, this is when growth shares shine.
"Slower growth should favour the growth style. The big proviso is that growth stocks need to deliver growth, which is not always assured given that the margin of safety in growth stock investing is typically slim," he said in a memo to clients.
"The past six to nine months have seen some cracks appearing on the earnings front for the growth style, although earnings for the growth mega caps have still held together reasonably well."
The US reporting season currently underway will provide many answers.
"The market will be weighing up earnings resilience versus latent cyclicality, that is, the ability to pass on cost pressures as well as the potential headwind from revenues pulled forward into the COVID earnings boom," said Cassidy.
"So far, results look better than feared – which has sparked a fresh rally in growth stocks – even though it is still early days."
A 'quality growth revival'
While we might be witnessing the start of a new renaissance for growth shares, Cassidy's team feels like the "highly speculative growth phase" seen over 2020 and 2021 is unlikely to repeat.
"In our view, if growth does reassert itself, it is likely to be a less dramatic, 'quality growth' revival."
"We think it makes sense to invest in quality-focused portfolios that can weather a slower business cycle and cope with cost pressures."
That means avoiding companies that are pre-revenue, have high debts or have poor cash flow.
In previous memos, Cassidy named CSL Limited (ASX: CSL) as a quality stock that's suitable for the current climate.
"Recessions rarely disrupt the need for medical care or medications," he said last month.
"CSL is the definition of a quality defensive — with resilient earnings, high ROE and the ability to positively surprise the market."
