(Bloomberg Opinion) – It’s a Growth Trap, and You’re Already Caught
Stock-pickers are used to the concept of “value traps.”Many a stockthat looks cheap turns out to be cheap for good reason. Fewer column inches have been devoted to “growth traps” —companies whose growth entices you in, only to disappoint. But that is changing in the month of May.
The month has seen the USstock market mete out immediate and cruel punishment to companies thatadmit to any problem with growth. After-hours on Wednesday, the chipmaker Nvidia Corp., a part of the NYSE Fang+ index, announced that first-quarter earnings had been better than expected. But theforecast for revenue growth was disappointing. This is what happened to its share price:
However, Nvidia waslucky. The month has seen a succession of far more drastic reactions to news from companies ranging from retailers (like Walmart Inc. and Target Corp.), manufacturers (Deere & Co.) and social media groups (Snap Inc.)In all cases, there was no scandal or big problem to reveal, but rather a disappointing failure to make as much money as hoped. The severity of the response shows that expectations of growth companies are high, and that there is no tolerance for a weakness. Even great companies became growth traps when their growth wasn’t quite strong enough:
It’s important to stress how relatively minor the issues were. Nvidia published earnings for the first quarter that exceeded expectations, but its revenue forecast for the current quarter was disappointing. At one point touted as the next trillion-dollar company, its market cap is now about to breach $400 billion. Target and Walmartboth complained about rising costs thatthey were not passing on to customers, thus squeezing margins; Deere actually raised forecasts for the full year, butwassold off due to disappointing sales. In all cases, supply chain problems and inflation had made life harder; and in all cases, any sign of difficulty in maintaining sales or margins amid rising inflation was taken as a cue to slash the premium the companies deserved for their growth.
In the early months of the pandemic, any company that seemed to have the ability to grow looked exciting. But in many cases, the hopes laid on them have proved excessive. And, it turns out, companies bought for their growth prospects always are more subject to hair-trigger selloffs than value stocks. Ben Inker of GMO, the Boston-based fund management group, defines a “growth trap” as follows in a new paper: “Any growth stock that both disappointed on revenues in the last 12 months and saw its future revenue forecast decline as well.”The same criterion applies to value traps —any value stock that disappoints on recorded revenues and revenue forecasts. This is Inker's estimate of how value and growth traps have performed relative to their respective indexes over the last 25 years:
Growth traps tend to create more damage most of the time, compared with other growth stocks. But the gap between growth and value traps has widened sharply this year. Growth stocks that have disappointed have been punished.
That may be in large partbecause long-term growth forecasts somehow became detached from reality during the heady months of the pandemic-driven boom. Several companies enjoyed a big one-timebusiness boost from Covid-19, and somehow the market seemedto have extrapolated this boost into the indefinite future. This chart, from Inker of GMO, shows the long-term growth forecasts for stocks in the MSCI U.S. Growth index, as reported to IBES:
The good news is that most of the excessive hope laid on growth stocks in the last two years has now disappeared. It was a brief but extraordinary victory of hope over experience. The bad news is that prospects for growth stocksare still deemed to be as good as they’ve been at any time in a quarter of a century. At a point when the debate over the macroeconomy swings between inflation and recession or both, that looks unrealistic. Itsuggests that there are other growth traps out there. It also explains why the market judgment has been so harsh on companies that barely disappointed; the bar of expectations had been set so high that it became impossible to clear.
Minutes Waltz
A frisson of fear passed through global markets Wednesday afternoon, to be followed by relief. The publication of the minutes of the last Federal Open MarketCommittee meeting (after a three-week delay)is not generally a big event. But every so often, the Fed’s governors can choose to use them to stage their message. In March, Chair Jerome Powell hinted thatdetailed plans on quantitative tightening would be spelled out in the minutes three weeks later —and they were.The great retreat from the stock market peak began after the publication of the December meeting minutes in the first week of January, which revealed that the Fed’s governors were already talking about QT asset sales. Would there be a similar land mine awaiting in the minutes from the May meeting?
No, it turns out that there wasn’t. There was no real surprise, and in the current heightened angst that was enough to buoy stocks into the close. Most of the document simply reconfirms what most people who’ve been paying attention would have expected; we should still expect 50-basis-pointshikes at each of the next two meetings.
However, there were a few coded messages. All the governors agreed on hiking by 50 basis pointsthis month, but that doesn’t mean they’re in total agreement about their future course of action. The emphasis in the following extracts is mine:
Allparticipants concurred that the USeconomy was very strong, the labor market was extremely tight, and inflation was very high and well above the Committee’s 2 percent inflation objective...
All participants reaffirmed their strong commitment and determination to take the measures necessary to restore price stability...
Most participants judged that 50 basis point increases in the target range would likely be appropriate at the next couple of meetings...
Many participants judged that expediting the removal of policy accommodation would leave the Committee well positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments...
Participants judged that it was important to move expeditiously to a more neutral monetary policy stance. They also noted that a restrictive stance of policy may well become appropriate depending on the evolving economic outlook and the risks to the outlook.
So, the Fed really thinks that the economy is strong, and isreally determined to do something about inflation. But there isn’t unanimity that there should be 50-basis-pointshikes at both the next two meetings. That creates the beginning of a route to slowing its tightening campaign if inflation falls further (and growth also falls further) than expected over the next couple of months. There is also a body of opinion, but by implication not a majority, who think that the advantage of tightening aggressively during the summer will be to give more of an option to reverse course in the autumn. There is at least a faction of potential doves in the committee. And the minutes-takers didn’t want us to know how many governors are inclined to move policy beyond neutral to be outright restrictive.
If “most” had been upgraded to “all” and “many” had been upgraded to “most” in the extracts above, the minutes might have changed opinions in the market. But they didn’t. Given the fear of Fed hawkishness, that meant the minutes were treated gratefully as a non-event.
There was one other key point of interest that should be concerning. The economists at the Fed have shifted their estimate for inflation at the end of this year upwardagain. The following chart from Omair Sharif of Inflation Perspectives LLC shows the projection for end-year personal consumption expenditureinflation rising from 2.6% in January, through 4.0% and now to 4.3%. As the top range of the Fed’s target is 3%, this means that the Fed is accepting that price rises will be less “transitory” after all, and trying to build expectations for more durable inflation. It also implies that the governorsare prepared to be a little more gentle in the measures they take to get inflation to come down:
The expectation that inflation would be all the way back down to the 2.0% target by the end of next year has been abandoned, with a projection now of 2.5%; many would still find this hopeful. Put all this together, and the minutes perhapsshowed a Fed slightly more resigned to durable inflation than was thought before, and slightly less militant in its commitment to rate hikes to combat this. But it’s marginal.
The bond market enjoyed one of its calmest days in a while in the wake of the minutes. For this we can be grateful. It’s been steadily positioning itself for the Fed to be somewhat less aggressive. Bond dealers might be proved right about this, but for now the Fed has left its options open.
If it’s possible to derive an over-arching message, it might be as follows. The FOMC is trying to calm things down and ready everyone for another two 50-basis-pointshikes over the summer. Something needs to go badly wrong to stop this from happening. But it’s quite keen to keepoptions open after that. If by the Jackson Hole meeting in late August it looks as though it will have to be more lenient than planned, there will bethe chance to shiftmessaging. And while growth has taken over as the greatest concern for the market in the last few weeks, it looks like the Fed is still more concerned aboutrising prices.If inflation should look as though it might fail to get down even to the revised forecast of 4.3% by the end of the year, there’s still a possibility that the Fed will have to be more hawkish than it currently intends, not less. But at least the path until the end of summer looks clear.
Survival Tips
Returning to the subject of mass shootings, which in this country is impossible to ignore at present. I’m thankful to the reader who pointed out that Woody Guthrie wrote a beautiful song about a massacre in Calumet, Michigan, in 1913. This is Woody’s version, and this is Arlo’s.More recently, Harry Chapin wrote the song Sniper about the massacre at the University of Texas in 1966. Both are chilling.
Maybe at some point there will no longer be an inspiration for songs like these,because the scourge of mass shootings can be ended. It's something to hope for.
John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”