If inflation subsides this year, 2023 could be a strong year for growth equities, according to Raj Shant, London-based managing director and equity portfolio specialist at Jennison Associates, a fundamental equities manager owned by PGIM.
Shant said 2022 has been “a terrible year for growth equity investing, probably the worst in absolute and relative terms for a couple of decades,” in a conversation with Conexus Financial managing editor Julia Newbould on the ‘Market Narratives’ podcast.
This was because an upward drift in inflation expectations through the year was bad for growth equity valuations, with a sharp downward adjustment in prices despite earnings for most growth equities continuing to come through, Shant said.
Consequently, growth equities have lost the valuation premium gained during the pandemic in 2020 as well as during outperformance in 2018 and 2019, and returned to relative valuations that were below the long-term average, he said.
Last year was a very difficult year, but it does mean that we are now going into 2023 at a lower than long-term, average valuation, Shant said, “an environment where the expectations for inflation and interest rates globally may have peaked.”
Companies that show the fastest sales and profits growth will be strong contenders to generate the best returns for investors in 2023, he said, if interest rates stabilise or start to be reduced. Whether that will happen is “up to each individual listener or reader to decide for themselves,” he said.
Investing successfully in growth equities requires active investment with strong bottom-up research, Shant said, pointing to Jennison Associates research which shows market expectations for which companies will be the fastest growing companies over the next five years are wrong 80 per cent of the time, when compared with the fastest growing companies in the market over five year rolling time periods.
“You don’t have to be exactly right, you just have to be more right than the market,” Shant said.
Different growth companies can have different characteristics that lead to different risk and reward profiles, Shant said.
What he termed “emerging growers” are younger companies that typically have more upside potential but also more risk and volatility in their growth. These could include cloud-based applications companies which invest in products, R&D and marketing at the expense of short-term profits.
“Stable growth compounders,” on the other hand, are larger companies with more mature growth rates that offer lower volatility and less risk. Examples of these companies are famous global luxury brands, and healthcare companies, Shant said.
In periods where interest rates and inflation expectations are relatively stable, emerging growers will often outperform. But in periods like 2022 where interest rates are rising or the backdrop is more risk-averse, stable growth compounders tend to outperform emerging growers.
Fintech in emerging markets is one of the biggest growth opportunities in the world at present, Shant said, owing to the incumbent banks tending to be more bureaucratic and cumbersome with less investment in consumer experience on their websites, apps and customer service.
Luxury goods also have strong growth prospects owing to emerging middle classes in major markets like India and China, and a desire among younger consumers to get “entry-level luxury goods” promoted by celebrities and influencers on social media.
Electric vehicles are also promising, Shant said, with huge growth over recent years, superior safety and driving experiences and strong environmental credentials, but still extremely low penetration in terms of the global fleet of vehicles.