Growth stocks will be challenged in 2022
Head of Equity Strategy
Summary: Looking ahead to the new year, we have asked the Saxo Strats what they will be looking at in the new year. In this article, our Head of Equity Strategy, Peter Garnry, takes a look at equities and specifically how growth stocks might be challenged in 2022.
In 2021, Investors were twice reminded that higher interest rates for equities that are priced on rather aggressive implied growth rates can plummet. But both times equities have come back, supported by strong earnings growth this year, as the economy came roaring back from the abyss in 2020.
In the past couple of months, we have seen multiple examples of growth stocks tumbling on earnings releases, due to what has generally been seen as a response to narrowly missing revenue growth figures. But in our opinion, this is actually not the right reason growth stocks have been sent on a downwards trajectory. Rather, it is the lack of improvement in operating margins that’s the culprit – and that is going to be a major theme within growth stocks in 2022.
One figure to put attention to connected to this is equity duration, which essentially is an expression of how sensitive a given equity is to increases in another financial figure, otherwise referred to as the discount rate – in this case the US 10-year yield. Many fast-growing growth companies have an equity duration of around 15-20, and some fast growing, but not profitable, companies may have equity duration of around 25-30, meaning that they in theory see their shareholder value go down by 15-20% or 25-30% if the US 10-year yield goes up by 100 basis points – or 1%.
The only way to offset that impact is by either improving the money earned by a company, i.e. revenue growth, or the amount of money you earn per dollar you spend, i.e. operating margin. The former is difficult when growth is already high and fiscal headwinds are likely to play a role next year, lowering the growth momentum. On the positive side, China is beginning to stimulate its economy, which could push growth in the right direction.
Still, the more likely scenario is that increasing growth in companies that already experience high growth in the current macro environment will struggle to improve revenue growth. That leaves the operating margin at the core of offsetting higher interest rates next year, should the bond market finally close the gap with inflation expectations. But improving operating margins might be difficult with wage pressures at unprecedented levels not seen since the 1970s and rising input costs from commodities and electricity.
The combination of potentially higher interest rates and difficulties improving operating margin from already high levels for many companies might prove too difficult or even impossible. That is likely the reason investors are reducing their exposure to growth companies and instead search for safe havens in mega caps as these companies have a better chance of preserving, or even increasing, their operating margin. Microsoft is a recent example, showing its market power signaling a steep increase in its price on some of its software.
We continue to recommend investors to reduce growth exposure and balance the portfolios with companies in the themes such as cyber security, logistics, semiconductor, agriculture, energy, financials, mega caps, and India. Overall, next year will prove difficult for equity investors with more volatility, less direction, and the battle between interest rates and profitability.
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.