Signs point to more upside ahead for growth stocks

As published in the Minneapolis Star Tribune 2/12/2017.

Ask your financial adviser if it’s a good time to invest and you will likely get a response that mentions current valuation.

One of the most commonly used metrics to calculate valuation is price-to-earnings or P/E ratio. Analysts and investors often will reference a stock’s P/E ratio compared to its historical average to determine if it’s a good buy.

P/E ratios also can be applied to an entire index, like the S&P 500. This exercise reveals U.S. equities to be relatively expensive with the S&P trading at 17.2x forward earnings, considerably higher than its 10-year average of 14.4.

Those figures, along with U.S. equities trading near record highs, could lead you to believe stocks are too expensive. However, our current economic environment points toward growth stocks being particularly attractive.

By almost any measure, the U.S. economy appears strong. Corporate earnings have grown by 4.6 percent in the past 12 months. The ISM Manufacturing Index is at a two-year high. Wage growth is the fastest since 2009. Unemployment nationally remains below 5 percent.

The bull market we have experienced since March 2009 has lasted longer than most. But economic expansions don’t die of old age and the recovery’s slow pace actually might increase its longevity. If the economy continues to strengthen, growth stocks are likely to outperform.
Accommodative policy by the Federal Reserve has led to historically low interest rates and encouraged investors to seek investments with higher yields. This has inflated the price of high-dividend value stocks. Looking ahead, however, rate hikes will be a headwind for those companies.

Relative valuation also favors growth stocks. As a category, the P/E ratio of large cap growth historically trades at a 40 percent premium to large cap value. That spread is now only 12 percent.

It’s already well documented that our new presidential administration prioritizes lower corporate taxes, deregulation and increased government spending to boost economic growth. Those initiatives should benefit all U.S. companies, but growth stocks in particular.

Finally, recent performance may indicate a rebound for growth is coming. In 2016, the 17 percent return for value stocks was more than double the return of growth stocks.

When the market prices growth stocks at historically low premiums similar to where they are today, investors typically are rewarded in the years ahead.
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