Growth Stocks are Slipping, Is A Down Market Coming? 5 Stocks to Protect Your Portfolio

rankings and lists Apr 04, 2021

Upon reading this headline you may either think to yourself, "Down market? The stock market is close to all time highs!" or you may be thinking, "why are my growth stocks getting crushed while the Dow Jones and other major indices are up?".

Regardless of which investor you are, or neither, we're seeing a potential structural change taking place in the market, driving the overall index higher. The change we're describing is a shift from investors holding ultra growth stocks to either GARP (growth at a reasonable price) or value stocks.

Why is this happening? It is largely due to inflation - which is highly unpredictable. But if inflation keeps going up (which we've seen this year with real estate prices, commodities and other prices going up) then we can see this structural change continuing to play out.


But why is inflation important?

Let's break it down further: When valuing any stock, investors are trying to predict what future revenues and cash flows a company is going to make in order to make bets (aka investments) on these future outcomes.

Should the investors be right about these future cash flows, they're often rewarded with the form of increased stock prices as these predictions materialize. However when predicting these future cash flows, investors often discount the cash flows back to present value in order to see what they're worth in today's dollars.

This phenomenon is known as time value of money.

Time value of money basically says a dollar today is worth more than a dollar tomorrow. And in order to see how much a dollar tomorrow is worth in today's dollars, investors use interest rates (highly influenced by inflation) in order to "discount" these to present day. Still with us? Let's walk you through an example with a company like Nike:


Nike Example:

If an analyst believes Nike will make $200 in 2022, $250 in 2023 and $300 in 2024, they will try to bring each annual cash flow to today's dollars to see what it is actually worth. The formula for discounting is FV (future value) = PV (present value) times (1+r)^n -> where r = interest rates and n equals years. While you can largely ignore this formula, when applying the math, what you see is a lower future value for any increase in interest rates.

Conversely, when trying to gauge present value, any increase in interest rates also leads to a decrease in present value! So at today's interest rates the cash flow above ($250 in 2023) may be valued at $240. But when the interest rates increase that same cash flow for Nike could be "discounted" to $230! With cash flows in the future worth less in today's dollars, the stock is valued less!

When this gets amplified out at scale growth stocks get really hurt! Why? Because if a majority of a growth stock's value is in the future years (as investors think it'll one day be a great company) higher interest rates lead to less worth! If inflation continues and interest rates rise, we'll continue to see this shift in the underlying dynamic of investors perpetually exiting growth stocks. And with this exit in growth stocks, where do they go?

Either GARP stocks or value stocks! These stocks either are growing, but with more precision and less overall expense (e.g. lower valuation) or value stocks which is where certain companies' stock prices do not reflect the value of the true price. Investors, by nature, are opportunistic and with less of an opportunity in growth stocks, we may see this transition as they look for new opportunities! While retail investors seems to be going towards highly speculative penny stocks and crypto's, the large whales have moved towards this area.

Pause. Exhale. Economic lesson over.


Top Value Plays for 2021

So now with that context, let's introduce several stocks that we believe are great to invest in, should this dynamic continue. Again, we want to reiterate that predicting inflation and interest rate movements is near impossible. However, this shift has historically happened once per decade and should that happen again we may see value and GARP stocks outperform for the foreseeable future. While we do not recommend liquidating all the stocks in your portfolio if they're growth focused, we do think buying some of the stocks below is a strong move for those looking to lower their risk and diversify a bit.

1) Valero Energy Corp (VLO) -> Dividend Yield (5%): Valero Energy Corporation is a Fortune 500 international manufacturer and marketer of transportation fuels, other petrochemical products, and power. With energy prices rising, and predicted to continue, VLO is in a prime position to not only appreciate but also return a strong dividend. Energy has underperformed for years and this may be the impetus needed to see the sector rise back to dominance.

2) Walmart (WMT) -> Dividend Yield (1.6%): Walmart is a strong stock that is still growing and can return a dividend for those patient investors. While Walmart still has a ways to go, this stock is much cheaper than some of their competitors (e.g. Amazon), and is still iterating. Walmart is a cheaper, more predictable cash flow stock, that has performed well this year and should continue to still remain strong!

3) Northrup Grumman (NOC) -> Dividend Yield (1.6%): We recommended this stock a while ago and our thesis still holds strong. NOC is cheap relative to the benchmark and they're continuing to win contracts at a strong rate. Stocks like NOC perform well in markets like this and its evident in the performance YTD. While pulling the troops out of Afghanistan does not bode well for NOC, advances in their technology amongst other business lines still bode well for the company. We've long been holders of NOC and will continue to be!

4) IBM (IBM) -> Dividend Yield (4.63%): We've always liked IBM, and while the pick isn't sexy, IBM has been proving everyone wrong for years! A powerhouse since the 90's, IBM continues to innovate and is one of the rare companies who can keep up with the times (to a certain extent). Given the "unsexyness" of the pick, IBM has a significantly lower valuation, but that's great for investors looking for a bargain growth play. Look at the top of market in march and the sell of in growth stocks and then look at IBM. They've continued to grow and that is a testament to the predicability of their cash flows and the faith investors have placed in them.

5) Equinix (EQIX) -> Dividend Yield (1.63%): Equinix is a real estate play that that specializes in internet connection and data centers. While its yield (1.63%) is significantly less than that of other REITs, this is more of a capital appreciation play based on the demand for the underlying property. With companies moving towards cloud storage and a limited capacity of data center, EQIX is in a unique position to hold these ever expanding data centers. As a inflation picks up and real estate inventory decreases, EQIX's properties can directly benefit from appreciation of real estate and is great way to hedge inflation!



Inflation Beneficiaries ETF (INFL): We wrote about this ETF recently but wanted to reiterate it should you want a straight inflation play. INFL's largest holding is TPL (which is our number 1 pick) at over 8%. The ETF is designed to seek long-term growth of capital in real (inflation-adjusted) terms. It seeks to achieve its investment objective by investing primarily in domestic and foreign equity securities of companies that are expected to benefit, either directly or indirectly, from rising prices of real assets (i.e., assets whose value is mainly derived from physical properties such as commodities) such as those whose revenues are expected to increase with inflation without corresponding increases in expenses.


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