Muscle Through a Recession With Growth Stocks

[Editor’s note: “Muscle Through a Recession With Growth Stocks” was previously published in June 2022. It has since been updated to include the most relevant information available.]

Lately, the stock market has been getting crushed. It’s clear that we’re in the middle of a bear market. And it seems likely that the U.S. will see a recession within the next 12 months. That’s if it’s not there already.

That may sound scary. But it shouldn’t be.

Recessionary periods and bear markets create once-in-a-decade buying opportunities in the stock market.

In other words, recession risks are rising, and the broader markets are highly volatile. But we’re growing very bullish on a particular group of stocks right now.

Historically, crises have created opportunities. This time is no different. And the opportunities we’re anticipating are potentially life-changing.

So, don’t freak out.

The best thing to do during a bear market or recession is to hunker down in stocks that will soar once the downturn passes.

The Hawkish Fed

The Fed will keep hiking rates. It made that abundantly clear last week. But the economy is slowing. So, we have a stubborn Fed dead-set on hiking interest rates into a rapidly slowing economy. That’s a situation very likely to result in a recession. And depending on the Fed’s policy path, it could even lead to a deep recession.

A mild recession is priced into U.S. stocks. A deep one is not. Last week, the odds of a deep recession were elevated quite significantly. Consequently, ever since, the stock, bond, and commodity markets have fallen. Investors are now more seriously pricing in higher odds of a deep recession in 2023.

Over the next few weeks, this negative pricing action will continue. Equity valuations are currently still bloated, and 2023 earnings estimates still call for big growth next year. Given that, we believe the potential downside risk for equities over the next two to three weeks is quite significant.

Indeed, we believe we’re in for a “grand finale” selloff for this current market crash.

That may sound scary, but consider this. This incoming fast-and-furious selloff should mark the market bottom.

And the biggest stock market returns of this century happened in the 12 months after bear-market bottoms.

How Much Farther Will Stocks Fall?

Every time the stock market crashes, it usually ends with a “bang.” Our analysis suggests this can be quantified by a sharp, ~20% accelerated selloff over the course of 15 trading days or less.

Once this happens, stocks usually bottom. But they never bottom until this happens.

In March 2020, stocks didn’t bottom until after they crashed 28% in just 15 days. In December 2018, stocks didn’t bottom until after they crashed 16% in just 15 days. They didn’t bottom in March 2009 until they crashed 18% in 15 days; and they didn’t bottom in July 2002 until they crashed 19% in 15 days.

On average, crashes usually don’t end until after the stock market plummets about 20% in 15 days. That’s the “Grand Finale” selloff.

We haven’t had that Grand Finale yet in 2022. Currently, stocks are about 11% off their trailing 15-day highs. At worst this year (in June), stocks were just 12% off their 15-day highs.

But that market bottom indicator is likely just a few weeks away. And once it arrives, stocks will be primed to soar once again.

Growth Stocks Win Once the Recession Risk Passes

At the top of this note, we wrote that we’re very bullish on a certain group of stocks at the current moment. That group is hypergrowth tech stocks.

I know. That may sound counterintuitive. But follow me here…

We’ve identified a particular group of stocks that have been unnecessarily battered despite sporting rising earnings and revenues. And these stocks have a very good chance of snapping back to all-time highs.

See the chart below, which illustrates the strong positive correlation between S&P 500 price and sales. Numerically, this is a positive correlation of 0.88 — nearly perfectly correlated. You don’t get much more closely correlated than that in the real world.

Regardless of a recession, solid growth companies will continue to grow their revenues and earnings at a very healthy rate over the next several years.

In other words, their “blue lines” from the above chart will continue to move up and to the right. Eventually, their “red lines” — or their stock prices — will follow suit.

That’s why we’re very bullish on growth stocks today.

Their blue lines (revenues) continue to go higher and higher, while their red lines (stock prices) are dropping sharply. This is an irrational divergence that emerges during times of economic crisis. And it always resolves in a rapid convergence, wherein stock prices rally to catch up to revenues.

Beating a Recession With Growth Stocks

Despite the present market climate, now is not the time to freak out.

Remember: Crises create opportunities. In stocks, this has been the case forever. This time is not different.

And in the current crisis, the opportunity is particularly large in growth stocks. We fully believe that once this recession risk eases — and it will — certain growth stocks will rattle off 100%, 200%, and even 300%-plus gains.

The investment implication? It’s time to hunker down in the right growth stocks.

On the date of publication, Luke Lango did not have (either directly or indirectly) any positions in the securities mentioned in this article.