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Some Stocks May Actually Benefit From Slow US Growth

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Good fundamental stock pickers may have the best shot at investment success under a scenario of slow GDP growth in the US and developed world.

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It's become part of the conventional wisdom to assume that the US is facing a decade or longer of slow GDP growth. However, even if this proves to be true (I take no position on that issue here), this doesn't mean that equity markets will necessarily become boring or that there will be few opportunities to make money in the stock market in the coming years.

Indeed, over the course of the next decade, certain types of stock investments should do extremely well despite, or even because of, slow growth in the US. Investors that comprehend these trends may be able to do extremely well.

Emerging Markets Stocks

The first group of stocks that could benefit powerfully from slow rates of growth in the developed world are emerging market stocks.

Low growth implies low interest rates and abundant liquidity. If the demand for corporate financing (equity and debt) is low in the US and the developed world due to muted growth, and if returns on capital are low due to the relatively low demand for capital, liquidity will tend do flow to markets where there's a greater demand for capital (equity and debt) and where returns are perceived to be potentially greater.

One of the defining characteristics of emerging market economies is the scarcity of capital. Thus, some of the primary beneficiaries of abundant global liquidity and low interest rates will be emerging market companies that will finally be able to acquire the necessary funding to finance high-margin and high-growth business plans. This bodes very well for emerging markets investing.

Growth Stocks

There are several reasons why growth stocks (including many emerging market stocks) should do well in an environment of slow growth in the US. This might seem contradictory, but it's actually quite logical.

First, slow growth implies low interest rates, slow overall EPS growth rates, and low overall rates of return on investment. Under such circumstances, many investors will feel compelled/tempted to achieve greater returns by venturing a bit further out on the risk spectrum. Investors will "stretch" for growth, thereby causing the PEs of growth stocks to expand.

Second, the scarcity of growth will make growth more valuable. The result is that the PE's of growth stocks will tend to expand. It's the law of supply and demand.

Third, low interest rates favor high duration over low duration. Growth stocks have relatively high average durations and value stocks have relatively low average durations. Why? In the case of growth stocks, a greater proportion of their cash flow and therefore value is derived from the out years. Low interest rates favor high duration over low duration -- growth versus value -- because cash flows further out in the forecast are discounted at a lower rate. Thus, low interest rates cause more multiple expansion in growth stocks than in value stocks.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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