Why Secular Growth Matters, and How We Find It

Growth stocks have lagged cyclicals so far in 2021, but we remain steadfast in our belief that secular growth is the key to generating long-term returns. In this piece, we discuss how we find attractive opportunities in the small cap universe.

Why Secular Growth Matters Now

In 2021, secular growth stocks have been relative underperformers. Through May, the Russell 2000 Growth Index has returned 4.1% YTD, while the Russell 2000 Value index has returned 27.5% YTD. This is also reflected at the sector level of the complete Russell 2000 index, with growth areas such as Information Technology and Healthcare underperforming cyclical sectors such as Energy and Materials.

Russell 2000 Performance by Sector

Source: Jefferies, Factset

The trend makes sense, as cyclical stocks are more sensitive to changes in GDP, and the economy has been expanding rapidly throughout the post-pandemic recovery. Not surprisingly, investors have been aggressively rotating into cyclicals during this period, as they were hit hard during the depths of Covid and were available at attractive valuations.

We feel this rotation has created an unusual buying opportunity for secular growth stocks, as they are generally 30% - 50% off their 52-week highs. When combined with their underlying growth rates, which have remained robust despite their tepid share performance, valuations look reasonable, especially on 5-year projected earnings.

Perhaps more importantly, we believe the present situation is an anomaly, and we expect growth stocks will reclaim their leadership position when the economy reaches its post-pandemic equilibrium. The current reopening process is (hopefully) a once-in-a-century event that has been driven by a powerful combination of pent-up demand and generous government stimulus. These tailwinds are both transitory, and when they abate, we are confident cyclicals will revert to more modest growth patterns.