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The Rise of Small Growth Stocks

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The landscape of the stock market is undergoing a significant transformation. The smaller growth stocks, often referred to as the “guppies,” have joined forces with the giants of the industry – the Big Tech names, also known as the “whales.”

For the small fishes, however, this newfound partnership presents a unique challenge. They must continue to navigate through the market swiftly, without diving headfirst into the fast-moving currents.

One notable performer this year is the iShares Russell 2000 Growth Exchange-Traded Fund (IWO), which has experienced a 15% increase, reaching $243. It is important to note that just a year ago, this growth fund hit a rough patch, plummeting by 69% from its record high of $333 in early 2021. The primary culprit behind this decline was the surge in interest rates. Smaller growth companies, known for taking years to turn a profit, often face difficulties in securing financing when rates rise. Consequently, their valuations suffer.

On the other hand, we have the Nasdaq 100 index, which houses the prominent Big Tech companies that are currently reaping substantial profits. This index has enjoyed a remarkable 38% increase, driven by advancements in artificial intelligence that have elevated earnings expectations.

It’s important to acknowledge that not all investors capitalized on the entire wave of Big Tech stocks, given their soaring valuations. Instead, many opted for smaller companies that exhibited solid relative value. This is how the small players received a boost from their larger counterparts.

Now, let’s address a question frequently raised by Wall Street experts: What about fundamentals? How did this rally unfold?

Fundamentals, unfortunately, do not offer much insight into the gains observed in small-cap stocks. Instead, investor positioning played a crucial role in propelling both the Big Tech and small growth rallies.

Several months ago, portfolio managers found themselves holding substantial amounts of cash, which they promptly invested in the large-cap players. Subsequently, they drove up the prices of the smaller growth stocks, allowing them to flourish alongside their larger peers.

In conclusion, the stock market landscape has witnessed a fascinating shift with the rise of small growth stocks standing shoulder-to-shoulder with the dominant Big Tech names. While challenges lie ahead for the smaller fish, their continued success will rely on their ability to navigate the market waters swiftly and strategically.

Market Volatility and Growth Fund Performance

Analysts have recently revised their earnings-per-share forecasts for the growth fund, resulting in a 12% decrease, according to FactSet. This adjustment has caused the price/earnings multiple to soar from below 30 to 37 times, which is particularly perplexing given the rise in interest rates.

In light of these changes, companies within the growth fund must now strive to generate significantly higher profits in order to maintain their stock prices. Furthermore, businesses operating at a loss need to work towards achieving profitability soon.

Despite these challenges, there are a few success stories within the growth fund. Progyny (PGNY), a provider of cost-effective infertility benefits, has experienced a market cap of $3.6 billion and a stock price increase of over 24% this year. Analysts anticipate sales growth of more than 30% to surpass $1 billion, along with rising profit margins.

Another notable company is GitLab (GTLB), an AI-powered operations and security platform for businesses. Following positive earnings in early June, GitLab’s stock experienced a significant boost. Beating sales estimates and reporting a narrower-than-expected net loss have contributed to a 15% increase in stock value this year.

Within the growth fund, there is a prevailing trend of price decline when it reaches the low $240s range. As a result, potential buyers are deterred by the high price tag. This pattern of decreased stock value applies to Progyny and GitLab as well. Progyny’s stock currently hovers around $38, just below its knockdown price of $40. Similarly, GitLab’s stock is trading near its low $50s level at $50.

This demonstrates that the market is not only punishing underperforming companies but also failing to fully reward strong performers within the small growth category.

Given the current market volatility, it is advisable to exercise caution and avoid making large investments in these turbulent times.

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