PGIM: Secular Resilience Amid Slowing Economy

LONG-TERM GROWTH REMAINS DESPITE CHALLENGING MARKET

Investors are grappling with the likelihood of recession in the U.S. and around the world. The ongoing war in Ukraine and frequently changing COVID policies in China remain unquantifiable risks. Persistent high inflation, resulting from the accommodative policies of the pandemic, has brought about a sharp reversal in monetary policy globally and an unusually abrupt tightening of financial conditions. In response, growth equities have gone through a grinding period of adjustment over the past 15 months. The starting point for the correction also coincided with high levels of absolute and relative valuations for growth stocks, resulting in significant underperformance.

The biggest retrenchment has occurred in companies that are not yet GAAP profitable, or where the pull-forward effects of the pandemic proved greater than we had modeled. The deceleration in revenue and earnings growth proceeded at a pace and scope beyond our forecasts. This trend was exacerbated by the strength of the dollar over the previous year and a half, leading to more negative translation effects than originally expected.

SOFTER EARNINGS GROWTH IN THE SHORT TERM

In the short term, we expect that fewer companies will generate earnings growth. We believe profit resiliency is likely to be as much a proxy for outperformance as expected growth under current conditions. We continue to focus on companies that have the products and services that meet today’s needs, while also investing for tomorrow’s opportunities. These businesses are well capitalized, against a backdrop of higher interest rates, and are likely to grow profitably at above-average rates over the balance of the cycle.

It has been nearly 15 months since the Fed announced its policy-tightening plans, and the market has adjusted to the new reality through sharply higher interest rates, lower growth expectations, and significantly lower stock prices and valuations. We expect greater clarity around the path of inflation, growth, and interest rates to emerge in the first half of 2023, accompanied by a bottoming in earnings expectations and sentiment. Our positive multi-year view incorporates the challenges that may continue to pressure the market in the short term.

SECTOR VIEWS

All investment styles finished a volatile year with gains in the fourth quarter. For the quarter and calendar year, value outperformed growth across capitalizations. Large-cap growth was the weakest market segment. Energy, industrials, and materials were the best performing sectors, while consumer discretionary was the weakest sector followed by communication services.

Longer term, we believe the market will continue to favor companies with asset-light business models, high incremental gross profit margins, subscription model revenue streams, disruptive products, large total addressable markets (TAM), and faster organic growth with long runways of opportunity. This is especially true as the overall real economic growth is expected to slow back to its post-global financial crisis average. If this occurs, growth will become scarce again and the market will pivot towards the select few companies that can produce it organically.

Jennison Associates’ 1Q23 Outlook highlights long-term optimism for resilient, durable growth stocks and why they will weather a slowing economy.

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