ASX growth shares made many investors wealthy for more than a decade until late last year.
But since late last year when inflation and interest rate fears gripped the market, they have been absolutely punished in favour of businesses that have better current cash flows.
So there's nothing we individually can do about that. But the big question in 2022 has been whether the rotation out of growth is permanent or temporary.
Some experts say growth stocks have had it far too good with near-zero interest rates and now it's a new era for value stocks to dominate.
In a recent blog post, the analysts at Pengana Capital Group acknowledged that 2022 was shaken by a seismic shift in conditions.
"Higher interest rates raised companies' variable borrowing costs which impacted profits," stated the analysts.
"Higher long-term interest rates also increase the equity discount rate of companies, which reduce the present value of future earnings and dividends – and hence the market value."
And, of course, such changes are more adverse for growth shares, which are more dependent on future earnings for their valuation, than value stocks.
However, the Pengana team is not convinced that growth shares are now permanently entering a long winter.
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The world has changed forever
Pengana analysts believe the world has changed irreversibly after enduring the COVID-19 pandemic.
Three trends in particular will stick around, to the benefit of many growth shares:
- Working from home
- Decarbonisation of the global economy
- Affluent professionals to delay having children
Telecommuting is a very obvious driver for many high-growth technology companies.
"This brings growth opportunities for a wide range of disruptive businesses as people continue to work and shop at home, whilst consuming media, entertainment and dinner 'from the couch'."
The recent US Inflation Reduction Act has given decarbonisation initiatives a tangible boost.
"Decarbonisation benefits companies in a range of sectors (e.g. electric vehicles, green project finance and renewable energy technology) that enjoy low sensitivity to the business cycle," read the Pengana memo.
"The war in Ukraine may lead to higher fossil fuel prices and more coal production, but only in the shorter term."
The delay in having children in developed nations will only be exacerbated by any economic downturn triggered from the steep interest rate rises. History shows populations have fewer children in times of economic distress.
"This will support secular growth in the demand for luxury goods and other consumer discretionary spending, much of which is supported by the resumption of leisure travel."
Pengana analysts reckon the sell-off has been so vicious this year that it hasn't just been poor business models that have been punished.
"Quality growth stocks across the board have underperformed value stocks, leaving some great companies priced at more attractive valuation levels," read their memo.
"This implies higher potential returns over the medium-to-long term."
Value shares have had their day
While value stocks in sectors like mining, energy, banking and consumer staples might seem attractive as the world heads into a period of economic pain, the Pengana team noted they have their limits as long-term investments.
Firstly, the good news for those value stocks is now already baked into their share prices.
"Continued outperformance of value stocks would require sustained outperformance in big sectors such as energy and financials."
Banks, for one, will not have much chance to enjoy charging mortgage holders higher interest rates.
"The banking sector is likely to face a slowing housing market with less new mortgage business," read the Pengana post.
"Over time the impact of rising bad debts will further offset the benefit to banks of wider lending margins, which is brought by higher interest rates."
Therefore, Pengana analysts warned, continuing outperformance by value shares can't be assumed.
"Growth stocks are now more attractively valued, will continue to benefit from long-term trends, don't rely on rising spending and do not face the challenges of the current 'hot' value sectors."
