Global growth stocks are looking expensive.
Some may even call them a bubble.
And given recent volatility in the likes of the Nasdaq and other growth-orientated indices, along with stretched market positioning, it’s got some asking whether the relatively small pullback earlier this month may be a sign of things to come.
Growth stocks are generally favoured for potential capital gains, rather than income.
In order to determine whether or not sectors like information technology and healthcare are in a bubble and prone to a substantial pullback, Citibank’s global equity strategy team have been looking at valuations using price-to-book (PBV) and forward price-to-earnings (PE) ratios compared to historic averages.
Called the “Bubble Tracker”, it looks at current valuations to previous stock market bubbles, deeming anything two standard deviations or more above the average of the past ten years to be in bubble territory.
The chart below shows current Z-scores for growth and value stocks, by region, using PBV ratios.
“We find that growth indices have moved into expensive territory everywhere,” says Citi, noting those in continental Europe and the US are already in bubble-like territory.
Nor does that change on a forward price-to-earnings basis, as shown in the chart below.
So growth stocks are looking expensive, but does that mean this potential bubble will burst anytime soon, mirroring what happened during the tech-wreck of the early 2000s?
To Citi, just because they’re looking expensive doesn’t automatically mean recent volatility is the start of a larger move to come.
“While current valuations of US Growth stocks are clearly starting to look stretched, they are still trivial compared to those seen in the late 1990s,” it says.
While no one really knows whether history will repeat, most Citi strategists favour value stocks over growth stocks at present, especially when it comes to financials and energy.
However, as shown in the table below, many of the bank’s strategists are still overweight growth sectors, particularly in IT.
“While we are sensitive to stretched relative valuations among the more growth-oriented sectors, we are also aware that they could get a lot more stretched,” says Citi.
“We are overweight two value sectors — financials and energy — because they look cheap and should eventually get a boost from higher bond yields and rising oil prices.
“But we hedge our exposure to the value trade by retaining an overweight in the big global growth sector, IT.”