Mainstream news outlets can’t get enough of the growth vs. value debate right now.
“Nasdaq tumbles as investors sell growth and buy value,” read one recent Reuters headline.
“Megacap growth tumbles as value shares advance,” a different Reuters article announced.
And Bloomberg wrote: “Rising [interest] rates… could drive investors toward value stocks, which tend to be more cyclical and offer near-term cash flows. That leaves growth shares wanting for buyers.”
In Wall Street speak, we call this a “rotation.” That is, the flow out of growth stocks and into value ones.
And it’s been front and center in recent weeks, after the tech-heavy Nasdaq took a tumble.
If you hold growth stocks in your portfolio, you may be wondering what to do about the recent volatility – and the mainstream media’s panicked response.
Should you dump tech stocks, and move your money into value stocks?
Not at all. In fact, the best thing to do during weeks where this rotation narrative is loudest is to ignore it.
Tomorrow, I’ll give you a way to keep your portfolio in check, no matter what the talking heads say about the growth versus value battle.
But first, let’s take a step back today. And let’s look at what this big debate – and the media’s recent scare – is all about…
There’s More to This Debate Than the Media Lets On
The New Year kicked off on the wrong foot for tech stocks. In the first week of 2022, the Nasdaq 100 Index registered its worst week since February 2021.
Now, February 2021 wasn’t that long ago, so it really wasn’t that big a deal. But that didn’t stop mainstream news outlets from sounding the alarm.
The prevailing reason they gave for the Nasdaq’s decline was that investors were afraid of what the Federal Reserve might do next. If the Fed raised rates, the argument went, it would choke the cheap money supply to the large tech firms in the Nasdaq.
For that week, the Nasdaq dove 4.5%, while the Dow Jones Industrial Average dropped by just 0.3%. But these moves were short-lived.
Last week brought a reversal on the performance of these two big stock market indicators.
The markets decided the Fed’s actions wouldn’t truly impact their overall trajectory to start the week… and then wobbled toward the end, on renewed uncertainty over what that would entail.
However, it was the Nasdaq that did better than the Dow that week.
This back and forth about what the Fed will do, and when it will do it, will be a fixture throughout this year.
But here’s the good news for you: There’s more to growth vs. value than a few red or green days in a row in the Nasdaq or the Dow.
You see, equating growth to the Nasdaq and value to the Dow is not indicative of what’s going on. Yet that’s exactly what the media tends to do.
This makes it seems as if the exclusive domain of the Nasdaq is growth stocks and of the Dow is value ones, and that companies must be in one camp or the other.
That’s not the case, though. Companies can walk and chew gum at the same time.
There Isn’t One “Right” Choice in the Growth vs. Value Debate
To understand what this means to you, we need to talk about some generally accepted definitions for value and growth stocks.
Value stocks are traditionally assumed to be cheaper than growth ones. That’s when using standard metrics such as price-to-earnings (P/E) ratios.
Investors also think of value stocks as less risky, and assume they pay a higher dividend to shareholders. Typically, value stocks are in sectors such as healthcare, financials, or energy.
Growth stocks, on the other hand, are thought of as being overpriced by the same metrics. Investors assume they have much higher P/E ratios, are riskier, and don’t usually pay dividends.
That’s because these firms want to preserve their capital or reinvest it in themselves to keep their rapid growth going. Tech companies tend to fall into the growth category.
During 2020, share prices of growth stocks shot up due to the pandemic. That meant the “stay-at-home” names – or names that corresponded most directly to the new behaviors that the pandemic catalyzed – did super well. Those companies included Zoom, Facebook (now Meta), Apple, and Netflix.
In the past, the value sectors tended to outperform growth ones during times when optimism about economic growth or recovery was greatest… or when inflation increases coincided with rising interest rates.
Growth companies tended to outperform when expectations about their future values were high.
If investors anticipate much higher revenues and earnings growth, they are more likely to ignore the high valuations that come with growth stocks.
With value stocks, investors tend to have fewer such expectations. And they’re okay with receiving the consistent dividends these stocks tend to pay – even if that means settling for share prices that don’t go up as fast.
But there’s no right choice. It’s like asking someone if they prefer vanilla ice cream with chocolate sauce or chocolate ice cream with whipped cream. It’s still ice cream.
Tomorrow, I’ll show you why the Nasdaq and the Dow are more similar than you might think – even though investors tend to divide them into the growth vs. value camps, respectively.
And I’ll give you a sure-fire way to dim out the “rotation” talk… and make your portfolio work for you in today’s complex environment.
Happy investing, and I’ll be in touch again soon.
Editor, Inside Wall Street with Nomi Prins
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