Perils of growth investing in slow economy

Fund managers who focus on finding stock supernovas have been getting burned.

By The Fiscal Times Aug 1, 2012 1:45PM
By Suzanne McGeeThe Fiscal Times

Growth managers must be glad that July is finally over. Now all they need to do is to figure out a way not to set themselves up for more sturm und drang in August and beyond.

As the portfolio strategy research team at Goldman Sachs (GS) pointed out recently, large-cap growth fund managers had a lousy month. When July opened, about half of them were lagging the Russell 1000 Growth index for the year. Three weeks into the month, that figure was up to 68%, and it's not likely that the final week of the month did them any favors.

The problem is that growth is proving extraordinarily elusive -- and the financial markets are awarding high multiples to only those companies that are able to complete Olympics-caliber feats of financial engineering. In contrast, investors are quite prepared to take stocks that disappoint even slightly out to the woodshed for summary execution. Facebook (FB) is one of the highest-profile such debacles; Apple (AAPL) is another. But there are a handful of these one-time market darlings that once seemed able or likely to generate healthy returns on both the top and bottom lines but that recently delivered similar disappointments.

All have been hit by what Bill Smead of Smead Capital Management referred to in a recent letter as "minefield" price declines: You step on it, it goes bang and you're left picking up the pieces of your portfolio from all over the place and wondering what happened to your five-year track record. A poster child for this group might be Chipotle Mexican Grill (CMG). One growth fund manager's son had even done a presentation on why the company's restaurants were so great to his grade-school class. The stock recently lost a quarter of its value after delivering disappointing quarterly results.

Part of the issue, Smead points out with the help of an analysis from institutional asset management firm GMO, is that growth stocks may generate market-beating returns one year but then falter and deliver sub-par results the following year.

It's also true that many of the stocks that growth stock managers have loved to own and in which they have accumulated big overweight positions -- Nike (NKE), Google (GOOG), Amazon (AMZN) -- are among the list of companies whose stock prices have fallen or flat-lined in response to underwhelming earnings.

It sometimes seems as if a select group of stocks finds such favor that portfolio managers feel they need to find an excuse not to own rather than one to buy. And too often, they allow a position in this kind of company to grow over time so that it takes on disproportionate weight in their portfolio. But in part because the company has become iconic in some way, to many managers it is inconceivable to think of it as being unable to deliver above-average growth in the future.

But the problem isn't just overweighting stocks that turn out to sputter -- or even explode when they hit that minefield. It's also about underweighting or even ignoring stocks that go on to outperform the index, as Goldman Sachs pointed out, citing recent standouts like Wal-Mart (WMT) and Walgreen (WAG).

There were plenty of valid reasons to shun Walgreen in July: Its June same-store sales results were utterly dismal, a sharp decline from previous months, and critics were arguing that the company had overpaid to acquire a stake in Boots, the British-based drugstore chain. It's the flip side of the bullish bias: There always appear to be plenty of valid reasons to ignore stocks like this or, at least, not to add them to a portfolio to any significant degree.

In a high-growth economy, these biases don't matter much, because growth is an easier commodity to identify and profit from. Not these days. With the economy apparently growing a measly 1.5% in the second quarter, and companies reporting revenues that are growing at a slower pace than earnings (which tells us they are making money by cutting costs rather than from growth), growth investing is going to be a far more perilous pastime in the coming months.

That has implications for investors, too. How confident are you that your growth manager is able to identify and capture growth once it becomes as rare as hen's teeth? If you're not all that confident, well, are you invested in a fund whose manager has the flexibility to shift styles as the market's mood changes? Can she decide to underweight large-cap growth and add a few companies that fall more into mid-cap value territory? These "go anywhere" funds may be the place to be during periods of tremendous uncertainty and volatility, when growth is either elusive or not rewarded by the market. Or you may want to look for managers who have proven they can find pockets of unrecognized value in a landscape dotted with distressed or struggling businesses.

The one important message of the last several weeks, as we have been bombarded by one earnings release after another, is that while those corporate profits have been better than analysts had been expecting, on average, those expectations were also rather muted. We won't be returning in a hurry to an era of solid growth -- indeed, it's possible we're heading into a period of stagnation. The economic forces aligned against growth are formidable, and include the Eurozone crisis and the "fiscal cliff" in the United States, which unfortunately looms just after this November's presidential election.

Remember, it was during the last presidential campaign that the full magnitude of the financial crisis of 2008 hit, having built up in the summer months when eyes were on other matters. With headwinds like this, and no growth tailwind to serve as a countervailing force, if you want to bet the farm on a "glamor' growth stock burdened by high expectations, you'd better be prepared to lose.

Suzanne McGee is a columnist at The Fiscal Times. Subscribe to The Fiscal Times' free newsletter.

More from The Fiscal Times



Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.


StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

125 rated 1
267 rated 2
455 rated 3
612 rated 4
682 rated 5
695 rated 6
632 rated 7
472 rated 8
279 rated 9
147 rated 10

Top Picks

TAT&T Inc9



Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.