It doesn’t seem to make sense. Why are tech high-flyers surging when economic growth expectations are faltering?
Goldman Sachs chief U.S. equity strategist David Kostin explained to CNBC why he expects the FANG stock rally to continue even in a sluggish economic environment.
“A modest growth environment means that growth is still relatively scarce. So the growth stocks … [where] tech is a prominent area, are likely to continue to do well and outperform,” Kostin said on CNBC’s “Squawk on the Street” Tuesday. “Basically you want to be in tech and particularly where there is secular growth. And there is a group of stocks where you have revenue growth that is double-digit and that’s still relatively rare.”
FANG stocks, an acronym created by CNBC’s Jim Cramer, are crushing the market this year with Facebook up 33 percent, Amazon up 34 percent, Netflix up 33 percent and Alphabet up 26 percent through Tuesday compared to the S&P 500’s 8.5 percent return.
“You have a group of stocks that are going to grow 10, 15, 20 percent, in terms of revenues … where they trade at 3, 4, 5 times enterprise value to sales, that’s the sweet spot that we look for,” the strategist said. FANG stocks “can continue to move higher.”
Slow economic growth, which leads to the growth scarcity situation boosting technology stocks may last for awhile.
The May jobs number came in sharply below expectations Friday and U.S. economy grew at its slowest pace in three years during the first-quarter. In addition, the time-line for President Donald Trump’s economic agenda keeps getting delayed.
Kostin said in the interview he expects a modest growth environment during the rest of this year. And he predicted Trump’s tax reform and infrastructure spending plans will likely be pushed out to 2018.
Counter-intuitively the strategist said if economic growth does improve, it will be negative for technology growth stocks.
“The big issue would be if you have economic growth accelerate, because in an economic acceleration environment, you want to be more value, more cyclicals as opposed to secular growth,” the strategist added.
Kostin’s investing playbook is similar to billionaire investor Stanley Druckenmiller’s classic investment strategy of buying high-flying growth stocks during low growth economic environments.
Druckenmiller is chief executive officer of the Duquesne Family Office and the former lead portfolio manager for George Soros. The billionaire’s hedge fund has generated annualized returns of 30 percent during his investment career.
“(I’m) long this high-beta, high-growth stuff, companies that are investing in their businesses. Stuff that I think will do very well with low nominal growth,” Druckenmiller said at The New York Times DealBook conference back in Nov. 2015.
He also clarified why stronger economies are bad for equities in a 1988 Barron’s interview.
“The best environment for stocks is a very dull, slow economy that the Federal Reserve is trying to get going,” Druckenmiller explained to Barron’s. “Once an economy reaches a certain level of acceleration, not only is the Fed no longer with you, but three bad things start to happen.”
The investor noted how in stronger growth economies the Federal Reserve takes liquidity out of the markets. In addition, he said companies build inventory for products and increase capital expenditures, which further diverts funds out of financial assets.