What happened
Growth stocks with a consumer business focus were bouncing sharply higher on Tuesday as inflation data came in cooler than expected and investors speculated that rate hikes may start slowing down.
Shares of fintech stock Block (SQ 1.68%) were up as much as 9.3% in morning trading, Roku (ROKU 2.94%) was up 13.9%, and Stitch Fix (SFIX -0.94%) was up as much as 17.9%. Shares are up 6.2%, 3%, and 6.6% respectively at 12:10 p.m. ET.
So what
Inflation data today is what the market is focused on. U.S. Consumer Price Index (CPI) data out today shows a 7.1% increase in prices over the past year, but prices actually dropped 0.1% from October to November. Rising inflation is the main reason the Federal Reserve has been raising interest rates all year and the market is speculating that will slow as inflation eases.
Target Federal Funds Rate Upper Limit data by YCharts
Even the idea of lower interest rates is welcome news to growth stocks. For one, avoiding a deep recession from a slowing economy would be good for consumer spending. All of these companies are reliant on consumers for growth, and inflation could both limit spending and raise costs for these companies. Operationally, that would squeeze margins.
On the market side, higher interest rates make investors demand more from growth stocks. Investors typically discount future cash flows to determine the value of a company, so higher rates mean a higher discount rate and less value on earnings many years in the future. This is one reason many growth stocks dropped dramatically in 2022.
Now what
For now, the market is speculating that both stocks and the economy have hit bottom. The Federal Reserve was raising interest rates to combat inflation and if inflation is no longer a major problem then rate increases may slow or stop. To be clear, the Federal Reserve itself has not given that indication yet.
While today's move and a lot of the reaction to inflation reports have been speculation, I do think there are some bullish signs for some of these stocks. But not all. You can see below that free cash flow at Block is positive while Stitch Fix and Roku are both burning money.
SQ Free Cash Flow data by YCharts
While I think it's a good time to be buying beaten-up growth and technology stocks, investors still need to be discerning. Capital is more expensive than it's been in over a decade and that'll keep a cap on the potential for companies that aren't profitable right now.
Out of these three, Block is the one company that I would be buying today and it should benefit if consumers are better off than expected in 2023. But that doesn't mean the stock won't have a bumpy ride as the market and economy look for a more certain future.
