Growth investing sees a burst of optimism

While both cash-generating and money-losing tech have rebounded during this period, the bounce in the most beaten-down stocks has been appropriately underwhelming. In fact, there is a clear lack of “market breadth” within the Nasdaq index with the larger, stronger and more well capitalized companies driving much of its gains. If this were the true beginning of an early cycle e recovery, we would expect the bear market’s worst victims (i.e., unprofitable tech) to be the best performers. In contrast, with the Fed still focused on fighting inflation and reducing its balance sheet, funding will be both scarce and more expensive for firms that lack a near-term profit trajectory. There is no doubt that some loss-making firms with transformative technologies will be the positive “wish I had invested then” headlines of tomorrow. Good ideas and strong management teams are likely to receive continued investment and show grit and persistence. CIO doubts, however, that such returns are earned in the short term. Survival will be in question for many of the experimental firms born in the Fed-driven easy money era.

‘Responsible growth investing’ for the next cycle

CIO does not expect growth investing to mimic the euphoric markets of 2020 and 2021. The times of indiscriminate outperformance for shares, coins or NFTs that don’t have sustainable value trajectories is over. But CIO does believe that with a higher level of discipline, growth investing will become one of the best ways to generate above-average returns in the next business cycle. CIO’s  framework for identifying compelling, potential high-growth opportunities incorporates the following considerations. 1. Think thematically: Identify sectors and themes with high total addressable market and relatively low penetration today. We must look to the next generation of technological advancement, in areas like AI, robotics, and cutting-edge computing as better avenues for identifying market-beating companies over the next decade. 2. Quality matters when money isn’t free: Find companies with a strong position within these industries and, particularly in the current environment, an ability to self-finance future growth. This suggests a bias toward larger, profitable firms over smaller upstarts. 3. Growth at a Reasonable Price, or GARP, over pure growth: Considering valuation in conjunction with a firm’s expected growth rate. This strategy has historically outperformed both pure growth and value investing, as it weeds out both overvalued growth stocks as well as value stocks in secular decline.

Bullish on AI

ChatGPT and similar programs are what’s known as Generative AI. Whereas previously AI could read and write, now it can understand and create content. The technology is not connected to the internet but uses billions of data inputs to formulate content. Generative AI has been used for some time. However, the release of ChatGPT has taken the technology and its use cases to the next level, capable of creating entirely new “copy” and content. PwC estimates that AI could contribute up to $15.7 trillion to the global economy by 2030. A large chunk of this is estimated to come from productivity gains ($6.6 trillion), ranging from educators grading exams to software developers writing or debugging code, job seekers creating resumes, or helping online content providers sell and advertise products and services. CIO sees companies that can provide the computing power and infrastructure to accommodate the growth in AI as major potential growth opportunities. These include hardware manufacturers of the most advanced semiconductors and cloud players on the infrastructure side. Other enablers and adopters of generative AI that form part of the ecosystem also stand to benefit.

Portfolio considerations

Within non-cyclicals, CIO looks at software firms which tend to deliver more stable profits, as well as firms tied to government subsidies and spending like electric-vehicle-battery producers and semiconductor equipment firms. CIO thinks these “defensive growth shares” will benefit from falling rates, and their profits won’t be as impacted by a shallow recession. Running some favorite themes through CIO’s preferred framework, CIO finds that cyber security, Emerging Market consumption, and Infrastructure & Onshoring score best when looking across valuation, growth, quality, and risk metrics. CIO’s themes related to longevity and biologics, which held up relatively well since the bear market began in 2022, look somewhat expensive when scaled by their typical growth rates. This suggests that some of the benefits from owning health care’s stable earnings profile is already baked into market pricing.

Note: Past performance is no guarantee of future results. Real results may vary.