An Overreacting Market
How AI pans out is unknown, but the growth stock rebound of 2023 isn’t mere speculation. Earnings have been strong. This isn’t the 1990s, when ‘eyeballs’ were cooler than profits.
Swings between euphoria and despondence go a long way toward explaining rotations in market leadership. Coming into 2022, growth stocks carried lofty valuations. They had soared in 2020 and 2021, as investors extrapolated the rate of pandemic-era technological change onto the future. Then, when inflation went from ‘transitory’ to ‘stubborn’ and the monetary policy response finally arrived, sentiment changed. Plus, Russia’s invasion of Ukraine gave a boost to the value-leaning energy sector.
In October 2022, Morningstar’s equity research team wrote “equities have rarely traded at such a deep discount to intrinsic values.” Microsoft, Alphabet, Tesla, Nvidia, and Meta, companies with durable competitive advantages, or ‘moats,’ were identified as bargains. This was based not on macro factors (or AI as a catalyst) but company-level cash flow projections.
Growth stocks don’t look as attractive today. Even the widest-moat company isn’t a good investment at too high a price. Investors would do well to diversify, paying attention to unloved asset classes like value stocks, small caps, and equities outside the U.S.
Patience is required, because valuation calls can take time to play out. See Japanese equities, which are finally rallying after years of disappointment. In the short run, markets will continue to be driven by a complex interplay of variables—fundamental and technical, macro and micro. Rationales that emerge after the fact to explain fluctuations often don’t stand up to scrutiny.
Dan Lefkovitz is a strategist at Morningstar Indexes
