The New Market Regime Demands High Quality Growth Stocks Available Through the ETF Formula

The market seems highly uncertain. At times it is the rotation from growth to value which is determining the direction of the markets. However, as evidenced by some of the sporadic upsides delivered by the NASDAQ, growth names have not capitulated yet. Using the ETF formula, whereby investors put their money into funds instead of choosing individual names, I compare two options for this new market “regime”. These are the American Century STOXX U.S. Quality Growth ETF (QGRO) and the SPDR Portfolio S&P 500 Growth ETF (SPYG).

The new market regime

In current circumstances, investors, mostly those who were used to benefiting from quick capital gains as the share prices of their growth names appreciated rapidly are now prone to headaches in trying to cope with the new market regime. To be frank, it is not easy to select the right value name, as in contrast to growth where you primarily look at revenue, there are more metrics to consider. These include profitability, forward cash flow, and valuations.

One solution is to opt for a value investment vehicle such as the SPDR Portfolio S&P 500 Value ETF (SPYV) where the fund managers have stringent criteria for selecting stocks. However, the choice between value and growth is not a straightforward one as there have been days like on Wednesday 19 when, in addition to impacting the high-growth names in the NASDAQ, the sell-off has been contagious to the Dow Jones Industrial Average whose holdings include many of the cyclical names with high profits and low valuations. Also, there are now talks of a “value asset bubble”.

The reasons for this market regime vary, ranging from high inflation impacting the financial sector, supply chain bottlenecks impacting industrials as well as fear caused by the Omicron variant potentially derailing the economic recovery.

Looking at a high growth ETF like QGRO

At the same time, analysts remain divided as to what stage we have reached in this growth to value rotation. To further complicate matters, many who were handsomely rewarded after trusting richly-valued tech or biotech stocks right after the spring 2020 market crash are buying the dips in the Nasdaq.

In these circumstances, for those willing to remain invested in growth, but through quality and rapidly growing stocks with better earnings, cash flow, operating income as well as lower valuation metrics, there is the QGRO.

Its main holdings include automotive, healthcare, and Information Technology plays with IT forming the largest sector with a weight of 41% as of January 18. It charges an expense ratio of 0.29% but pays dividends with a better yield of 0.31%.

Source: ipro.americancentury.com

In line with my strategy to always look for alternatives, I scanned the industry for similar ETFs.

SPYG delivers better performance

I found the lower cost SPYG which comes with an expense ratio of only 0.04% and pays dividends with a higher yield of 0.68%. Now, SPYG is more passively managed, but it also comprises a significant amount of IT holdings or 43% of overall assets. Furthermore, with tech being in the line of fire because of high valuations concerns, I checked whether the SPDR ETF also suffered in the same way as QGRO, and this, through a comparison of their short-term historical performances.

This was not the case with SPYG’s three-month performance being at -0.56% compared to -6.19% for QGRO, which has clearly suffered more. Now, this period, whose beginning is denoted by the green marker below, has been characterized by tech sell-off, and the fact that the SPDR ETF has delivered less underperformance shows that it is able to withstand volatility better.

Source: Trading View

This advantage may be due to its number of holdings exceeding QGRO’s by 37, implying fewer concentration risks, but SPYG’s real strength lies in the names held. These include the MANAMAT stocks, with the acronym standing for Microsoft (MSFT), Apple (APPL), NVIDIA (NVDA), Alphabet (GOOG), Meta Labs (FB), Amazon (AMZN), and Tesla (TSLA). Combined, these seven stocks represent 51.3% of SPYG’s portfolio.

Conclusion

According to SPYG’s fund managers, the index they track contains stocks that exhibit the strongest growth characteristics based on: sales growth, earnings change to price ratio and momentum. This has proved true with SPYG delivering a better one-year price return at 20.12% compared to QGRO’s 6.47%.

Consequently, the SPDR ETF is better based on historical performance.

Finally, to be fair, SPYG was incepted back in September 2000, while QGRO is much younger as it was created only in September 2018, and with the high level of market volatility looking to persist throughout, I will be watching closely at the American Century ETF. One of the items I will be focusing my attention on is the dividend yield as the fund managers lay particular emphasis on the profitability and cash flow metrics.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.