In May 2020, Tesla CEO Elon Musk unexpectedly tweeted that the company’s share price was too high. The shares, of course, immediately plunged. More recently, his Twitter poll asking if he should sell a chunk of his shares also caused a sudden price drop.
Elon Musk also does his best Twitter work while sitting on the can. Don’t take my word for it, just ask him:
Naturally, it might make a few investors uncomfortable that Elon Musk can dramatically move Tesla’s share price with a simple tweet from the commode, but lately, this is just one of many reasons that investors are becoming uncomfortable with Tesla stock.
But it’s not just Tesla. Many of the other high-growth companies that have dominated equity markets and headlines over the past few years are also making investors wary.
First, growth stocks are expensive. Growth stocks are traditionally compared to value stocks and growth stocks are now the priciest they’ve been relative to value in more than 20 years:
Growth vs value: relative valuation
Source: JP Morgan, Russell 1000 Growth Index vs Russell 1000 Value Index. Forward P/E.
I’ve cautioned before that valuations aren’t terribly predictive of future index or share-price direction, but when they drift into these unusual ranges, it’s worth paying attention.
Second, valuation takes on added significance when concentration risk increases and earnings power fades. The top 10 positions in the S&P 500, for instance, which are almost all growth focused, now comprise more than 30% of the Index, an elevated concentration level not even seen during the heady technology-bubble years (see chart below). And the earnings contribution of these 10 stocks, which sat at close to 35% in mid-2021, has now dropped to less than 26%.
Weight S&P top 10
Source: JP Morgan
Earnings contributions S&P 500 top 10
Source: JP Morgan
Finally, we have the virtual certainty of many Fed interest-rate hikes this year. Naturally, bond yields are already pricing this in with the US 10-year Treasury yield up from 1.4% to almost 1.9% in just the past month. Growth stocks face more sensitivity to higher interest rates. There are a number of reasons for this, including how the market values future cash flows and the higher cost of borrowing (something growth companies tend to do more of), but the bottom line is that sharply rising interest rates are an added headwind for growth stocks.
So growth stocks have had a rough start to the year, down almost 8%. One of the first changes we’ve made this year in our client portfolios is to trim growth and add to value. But keep in mind that all of the above is an argument for TRIMMING growth, not abandoning it entirely.
When constructing a portfolio it’s never prudent to entirely exit a region, a sector, a style or an asset class. Such decisions recklessly presume an infallible thesis and only create concentration risk. However, tilting a portfolio to improve performance or hedge risk is always fair game and we get paid to actively manage.
Therefore, for 2022, we’re swapping some growth for a bit of value.
Tesla may have another spectacular year, after all, betting against Elon Musk hasn’t proven wise in the past. Or it may not. However, with respect to growth stocks as a whole, we think that the risk of underperformance is increasing.
At the very least, by trimming growth, we’re reducing volatility every time Elon Musk takes a bathroom break.
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.