Barbells and Balance: Our Prudent Pursuit of Growth

Matt Freund, CFA, Michael Kassab, CFA

Summary Points:

• Although we are optimistic that macroeconomic conditions can provide a favorable environment for growth stocks, we recognize that risk management is as important in advancing markets as it is in declining ones.
• We have positioned Calamos Growth Fund in high-quality, innovative companies, balancing secular growers with more defensive growth opportunities.

Cautious Optimism Amid Crosscurrents

During the third quarter, investor concerns over softening labor market data eventually gave way to market enthusiasm over the Fed’s decision to jumpstart this rate-cutting cycle with a “jumbo cut” of 50 basis points. In the end, the S&P 500 Index again reached new all-time highs.

While growth stocks posted their fourth straight quarterly gain, they took a backseat to value stocks for the first time since 2022. Against a backdrop of declining Treasury yields, the more yield-sensitive segments of the market (primarily financials, real estate, and utilities) played catch up the past several months, and small-cap equities rallied on the prospect that lower rates would disproportionately benefit companies more reliant on the capital markets to fund their growing businesses.

Looking Ahead

As we enter the final quarter of 2024, the US equity market finds itself at an intriguing juncture. Despite some uneasiness about moderating employment growth and consumer spending, broader macro data still points to an economy that is more resilient than many anticipated it would be at the outset of the year. At the same time, the Fed made it clear it is now fully back in accommodative mode. This combination has fueled hopes for a soft landing or perhaps a “no landing” scenario for the US economy.

Several factors support a cautiously optimistic outlook. Although segments of the population—particularly those living paycheck to paycheck —have been showing signs of financial duress, receding interest rates and inflationary pressures should bring much-needed relief over the coming quarters. Manufacturing activity has also shown signs of stabilization after weakness earlier in the year, and corporate earnings growth has broadened beyond the "Magnificent Seven" tech giants, with S&P 500 earnings expected to grow 9% in 2024 and 15% in 2025, according to Wall Street estimates.

Historically, rate cuts amid a stable economic backdrop have been very supportive of risk assets. However, investors should remain mindful of potential headwinds. For starters, the S&P 500’s forward price-to-earnings ratio remains meaningfully above historical averages. We would not characterize this as overly alarming, particularly since the weight of mega-cap stocks somewhat distorts this valuation metric. Nevertheless, it remains true that growth stocks, on the whole, have less room to run on further multiple expansion going forward. Ongoing geopolitical conflicts, trade tensions, and the upcoming US presidential election could also introduce volatility.

Positioning for Q4 and Beyond

Given this environment, we maintain a balanced approach to US equities. We continue to favor high-quality growth stocks, particularly those we believe are well-positioned to capitalize on the ongoing AI revolution as it moves from nascent stages to having broader societal and economic impact. Our strategy advocates for a barbell approach, balancing exposure to secular growth themes with more defensive, high-quality names that can provide stability in periods of volatility. Active stock selection becomes increasingly important in an environment where market correlations decrease and dispersion rises.

Although we see the potential for further upside in US equities, we caution that risk management can sometimes be ignored in strong markets, especially when new all-time highs dominate the headlines. We believe risk management and selectivity are as crucial as ever, especially given elevated valuations and macroeconomic uncertainties. Investors should be prepared for potential volatility around the upcoming election and escalating hostilities in the Middle East. Focusing on quality, innovation-driven growth, and maintaining some defensive positioning should serve investors well as we navigate the crosscurrents in the US equity market.