Originally posted by StefanF
Hey mate I feel your post is rather contradictory. If the US and world economy is slowing, why would you invest in growth stocks? Seems counter-intuitive. Interest rates decrease would be expansionary monetary policy which would be in response to declining economic conditions and by extension reduced inflation rates. Decreased interest rates would be a lagging action and the share market would have dropped substantially before this happens. Additionally, lower interest rates have a positive impact on all shares due to the valuation models using a lower discount rate, this isn't specific to growth stocks but this positive impact is more than offset by slower economy activity.
Just to clarify, the stocks that get hit hardest in an economic slowdown are growth stocks since their valuations are very much tied to growth. The stocks that tend to do better in a slowing economy are the defensives, such as consumer staples and utility stocks which produce steady cashflows even in a recession and can continue to produce dividends. These defensives are high dividend yielding stocks with low capital growth, so I would not recommend buying growth stocks if you believe your own scenario of slowing economic activities with lower interest rates.
Hope this makes sense and I hope you find this information useful.
Cheers.
Hey
@StefanF ,
Been on a overseas work conference so delayed in responding here.
Firstly great question and reading your post you have a good understanding of the market and the logic you have applied is correct. The difference between our posts is in the assumptions. When i refer to "Growth stocks" i am referring to "Secular Growth Stocks" meaning they will have a growth profile irrespective of the economic conditions. In your post you are assuming the grow stocks will stop growing or the growth rates will reduce in a recession and thus the stock price should be impacted.
So the question now becomes what evidence or data points can we use to see how NXT will preform in a recession or slowing economy. The best chart I found is the one below. It is Equinix's annual revenue since 2002. As you can see below every single year the revenue has gone up. Even in the midst of the worst recession (GFC) since the depression, revenue was going up. This is even after you strip out inorganic M&A growth).
[source:
https://seekingalpha.com/article/752881-equinixs-journey-to-3-billion-sounds-achievable]
The reasons the revenue keeps going up is it has many of the attributes you and subsequent posters have eluded too.
- Datacentres have long term contracts 5 years+ with fixed recurring revenue from companies (Microsoft, Amazon, Google) that have good credit i.e. NXT customers are unlikely to go bust
- They behave like utilities/Infrastructure. NXT bills in MW's which is exactly like energy utility. They have long term assets that are capital intensive that pay off over a long time.
- The demand for they services is secular - driven ultimately by consumers (be it primary, secondary or territory demand via digital transformation)
I thought i take the opportunity to respond to your post in more detail. I personally learnt a lot over the years reading articles and other forums posts and learnt of others. Least i could do. S = statement.
Q. If the US and world economy is slowing, why would you invest in growth stocks?
A. Provided you invest in secular growth stocks which maintain their growth profile even in a recession, people will pay a premium for returns and growth. Once the economy slows down and the interest rates come down there aren't many asset classes that will provide good returns. Investments in cash and bonds will be low, as the whole point of reducing rates is to get people to invest into riskier asset classes and consume goods.
S. Interest rates decrease would be expansionary monetary policy which would be in response to declining economic conditions and by extension reduced inflation rates.
A. yes interest rate decreases are inflationary. But you have the cause and effect around the wrong way. Inflation is the "cause" that shifts interest rates "effect" . Most central banks will have a dual mandate. One is ensuring growth is around the 2%-3% mark and the second is maximum employment. So the reason the Fed Reserve raises rates is either inflation is increasing or is about to increase. They preempt inflation via employment figure, wages, etc. What is interesting about the recent rate rises is that though inflation is increasing it isn't increasing at high levels the Fed should be raising rates as quickly as they are.
S. Decreased interest rates would be a lagging action and the share market would have dropped substantially before this happens.
A. Yes.The stock market is definitely a leading indicator.
S. Additionally, lower interest rates have a positive impact on all shares due to the valuation models using a lower discount rate, this isn't specific to growth stocks but this positive impact is more than offset by slower economy activity.
A. Yes, lowering interest rates will reduce the 10 year treasury yield which is typically used as the risk free rate for asset valuations.It is not correct to say that reducing interest rates will more than offset slowing economy. Look at the GFC, reducing interest rates wasn't enough for many companies. in severe recessions and depressions Monetary policies typically aren't enough. The companies with the poorest credit will always collapse first.
(20min delay)