Growth stocks in an environment of rising interest rates

Thrugelmir

There's no direct correlation between selling prices/revenue and inflation. Besides which inflation isn't uniform around the globe. Some companies likewise will have an aggressive pricing strategy to take market share.  Indexed linked Government stocks and other forms of investment such as Infrastructure funds are already expensive to purchase. As many investors have been starting to hedge their portfolios for some time.  

aroominyork

Apodemus said:

aroominyork said:

What would be a straightforward metric to assess how much debt a company is carrying relative to its size, perhaps using the financials on this page as an example?

Debt/Equity ratio.  In this case, about 12.

Apodemus said:

...or perhaps more significantly, the debt/equity ratio has grown from a fairly stable 3.6-4.2 over the first four years in your table to 12.3 in the most recent figures to April '20.  On it's own that doesn't tell you much, but it indicates a significant change in the business, which might be worthy of further investigation.

Can you please point me to the exact data lines? Still trying to figure this out.

MaxiRobriguez

aroominyork said:

Thanks for the discount rate explanations. However, if interest rates are raised to control inflation, and assuming a company's prices/revenues rise in line with inflation, isn't there a zero sum game of whether to invest in the company which might generate the same revenues in real terms, or invest in bonds which might also just track inflation?

There is also the consideration that markets are irrational. If investors believe that growth stocks will decline in a rising inflation environment then growth stocks will get sold off, almost regardless of the underlying numbers. Similar thing happens with gold as a hedge against inflation - people hold it because they expect it to be a decent hedge despite gold prices having no positive correlation with inflation historically. 

Hive mind rules.

bd10

I think Mr Pensioncroft was addressing the wrong question. The issue is not so much about rising nominal rates but fall real rates. We should see some interesting CPI prints later this year if not next. And then the real question is whether central banks will act or not. I wouldn't be so sure that they'd start to tighten. There is too much covid debt hanging in the air that needs to get paid off. Higher taxes are in te office, that we know, but a good dash of inflation should do the trick. Keep headline inflation at 3% (the actual would be higher of course, more like 5%), give it about 10 years...

So the question should be how to invest during inflationary times and not when nominal interest rates rise.

Apodemus

aroominyork said:

Apodemus said:

aroominyork said:

What would be a straightforward metric to assess how much debt a company is carrying relative to its size, perhaps using the financials on this page as an example?

Debt/Equity ratio.  In this case, about 12.

Apodemus said:

...or perhaps more significantly, the debt/equity ratio has grown from a fairly stable 3.6-4.2 over the first four years in your table to 12.3 in the most recent figures to April '20.  On it's own that doesn't tell you much, but it indicates a significant change in the business, which might be worthy of further investigation.

Can you please point me to the exact data lines? Still trying to figure this out.

Total Liabilities c£360m  Total Equity c£30m.
Or looking at it slightly differently, of Total assets of £390m, £360m is debt.

A high gearing ratio can be good, if the company is generating profit by using someone else's money.  But the general point being made on this thread has been that gearing becomes more risky in periods of high interest rates, if the cost of debt rises faster than revenue. 

YellowStarling

I follow the logic that a rising interest rate environment is more challenging for valuations of growth funds and stocks (albeit argument re: low debt/equity ratios accepted).

However, I came across an article that claims:

"...an analysis of the 13 rising-rate environments over the past 64 years found that the tech sector of the S&P 500 gained an average of 20% during the 12-month period following the first rate hike of each cycle. Health care stocks, meanwhile, represented the second-best-performing sector, with a 13% average gain.

"The worst-performing sectors were financials at 4% and materials at 3%.

"This compares with an average gain of 6.2% by the S&P 500 over the same 13 rising-rate cycles."

Source: Time is right to invest in sectors that do well as interest rates rise - InvestmentNews

Now, a few points (not exhaustive) which may or may not be significant to the value of this article (please feel free to add your corrections and/or thoughts):

1) It's over 10 years old - has the landscape operated in by the principles we're discussing, or even the principles themselves, altered too much to carry the article's water 11 years on?
2) I am equating tech and healthcare sectors with growth - is this (too) lazy of me, particularly when - as with (1) - we're a further 11 years on and tech is only increasingly found in the make-up of global funds and indexes?  I appreciate healthcare as a sector is just as broad, if not more so - from Big Pharma to pre-approval biotech - so the sector's component parts may not be strictly growth.
3) Is it possible that growth companies are more likely to reinvest profits rather than pay out dividends - to this end, could this reduce their borrowing in an environment of high(er) costs of debt?  And does this reduction in borrowing carry through to the (according to the article's analysis) relatively poorer performance of the financials sector, i.e. banks and lenders are paying higher interest on an increased propensity to save which struggles to be offset by reduced lending at what would be more favourable revenue-generating rates?
4) The article is clear that the analysis uses the rate hike itself as the starting point for the period of performance monitoring - right now, we have not yet had a formal rate hike in the major economies.  Is it possible that market sentiment returns to growth once the rate hike is 'official' and the pivoting from growth to value/cash/other hedges we've observed in recent weeks occurs instead in the run-up/anticipation/inflationary settings?
5) The article does not offer whether the tech and healthcare sectors actually declined in their rates of growth following the rate hike whilst still managing to outperform the other sectors, and/or whether the rate hikes themselves were either followed by further hikes or took longer than 12 months for their impact to bear out in the market (in other words, whether the sector performance would have significantly switched in year 2 onwards).  This may be moot for those interested in micro-term impacts of economic policy/environment on investments as the article is clear in its claims that, for 12 months at least, the best performance was to be found in what I've already (perhaps wrongly) attributed to, broadly speaking, growth investing.
6) The article uses an average of 13 events/periods.  It's possible that the performance of the sectors is skewed by one or more exceptional periods that may in fact contradict what is seen in the others.  Perhaps some other method of averaging could have assisted (such as the number of times tech beat financials, etc.).

Prism

I imagine that once a dividend increase has occurred then there is a lower chance of there being another in the immediate future. The stock market is predictive so it would be more interesting to see the effects on growth stocks before the rate increase and likely before the rate increase was even announced. This seems to be what is happening this year so far. 

Eco_Miser

A small point, but the meaning of 'technology' has changed a lot since 1946 - for example, what we understand as computers didn't even exist then outside highly secret military projects; now nearly everyone carries a super computer with them everywhere.

Thrugelmir

YellowStarling said:

I follow the logic that a rising interest rate environment is more challenging for valuations of growth funds and stocks (albeit argument re: low debt/equity ratios accepted).

For growth stocks the Nasdaq is the main index to research Not the S&P 500.  Growth stocks are highly likely to be unprofitable. Which makes them ineligible for inclusion to the S&P 500. One reason behind Tesla's delayed inclusion. Despite it's huge market capitalisation. 

Apodemus

In statistics, there is always a risk that if you analyse enough variables, you'll find two that show something that looks like a significant relationship when no such thing exists.  To draw any conclusions that stand up to scrutiny, you would need to factor in the trigger for the rate rise, the length of time since the previous rise or fall, the scale of change, the onward trajectory etc.  And at the end of the day 13 occasions is just too small a sample to be meaningful.