Growth stocks ruled the market for much of the last decade, benefiting from a low-interest-rate environment and strong growth in the tech sector.
However, that track record of outperformance came to an abrupt end in 2022 as interest rates jumped, and many companies posted disappointing results as they faced difficult comparisons after strong growth during the pandemic.
As the chart below of the Vanguard Growth ETF (VUG 0.09%) shows, growth stocks are still barely off their lows from this year, and the index fund is still down nearly 30% for the year, significantly underperforming the S&P 500.
Despite the underwhelming performance in growth stocks this year, there are reasons to be hopeful of a turnaround. Let's take a look at both sides of the argument here.
Why growth stocks could be ready for a comeback
While the macroeconomic environment has spooked investors this year, there are signs that the situation is changing in favor of growth stocks.
First, inflation rates are cooling significantly. Year-over-year inflation, as measured by the Consumer Price Index, cooled to 7.1% in November, its slowest pace since last December, and down from 7.7% in October. On a month-over-month basis, the consumer price index rose just 0.1% in October, and on an annualized basis, it's up just 2.4%, close to the Federal Reserve's goal of 2% inflation. Core inflation, which excludes food and energy, has also slowed, rising 0.2% in November on a monthly basis and 0.3% in October. Comparisons will get even easier next year, and if those trends persist, it's possible that the CPI could approach the Fed's 2% goal by the end of next year, if not sooner.
The Fed, meanwhile, sees its preferred measure of inflation, personal consumption expenditures, falling from 5.6% at the end of this year to 3.1% at the end of 2023.
Additionally, the unemployment rate has remained low in spite of monetary tightening. While Fed Chair Jerome Powell seems to think that unemployment needs to increase in order to bring inflation down to 2%, the best-case scenario for growth stock investors is that inflation cools off without a spike in the unemployment rate.
Image source: Getty Images.
Why growth stocks could fall further
After the latest Federal Reserve rate hike and commentary, investors once again seem nervous about a recession as the Fed hiked its estimates for the fed funds rate next year, predicting the benchmark interest rate will increase another 75 basis points to 5% to 5.25% in 2023.
Of course, whether that happens depends on inflation and other factors, but the central bank still hasn't seen sufficient evidence that inflation is falling to persuade it to relax rate hikes.
The other question facing growth investors is if the economy will sink into a recession next year and whether there will be a "soft landing" or a "hard landing," meaning inflation will or won't normalize without a significant economic downturn.
If the economy continues to deteriorate, growth stocks are likely to fall further. If that happens, it will take either a change in interest rate policy from the Federal Reserve, as a recession could even lead it to lower rates, or a clear rebound in economic activity to persuade investors to move into growth stocks again.
So are growth stocks safe?
No one can time the market, and no one knows for sure when growth stocks or the Nasdaq will hit bottom or if they already have.
If you're asking whether growth stocks are safe, that depends on your time horizon. If you're planning on holding growth stocks for five years or longer, then now looks like a great time to invest. There are a number of disruptive growth stocks like Airbnb, Shopify, and Roku that are trading at a significant discount to their previous heights, and big tech companies like Alphabet and Amazon also look well-priced long-term growth. If you just want to hold them for a few months or a year, then you're taking on a lot more risk.
What happens next year is still anybody's guess. Growth stocks like these could continue to fall as the economy remains volatile, but over the long term, buying high-quality companies like the group above at fair prices should pay off.
