Have Growth Stocks Bottomed?

Source: Thinkstock

Source: Thinkstock

Throughout much of the year, but particularly since March, several heavily owned growth stocks have been trending downwards. Some of these include:

  • Mastercard (NYSE:MA), which is down 11 percent for the year.
  • Starbucks (NASDAQ:SBUX), which is down 11 percent for the year.
  • Amazon (NASDAQ:AMZN), which is down 19 percent for the year.
  • Biogen Idec (NASDAQ:BIIB), which is down 17 percent in the past month.

These stocks rose unabated last year, and it should come as no surprise that they are correcting. Late last week, however, these high fliers turned around and began to move upwards once again. This begs the question — is it time to get back into these large-cap growth stocks again, or is there further downside? While the corrections we have seen have been more substantial than the norm for the past couple of years, I still think that they are going to continue in most of these cases. I cite the following reasons.

First, in a bull market, it is not uncommon for quite large corrections to take place. For instance, Apple (NASDAQ:AAPL) shares traded from $180/share in 2007 to $75/share in 2009 before flying to $700/share. The price of gold fell from about $200/ounce in 1974 to about $100/ounce in 1976 before spiking to over $800/ounce.

The reason for this is that when asset prices begin to move up, a lot of traders become involved, and they drive prices even higher. They don’t buy assets because they believe in the fundamental cases for owning them; rather, they buy them because they expect to be able to sell them at higher prices. Thus, when the uptrend turns against them, they are forced in a position where they have to sell. This, in turn, creates negative momentum, which entices traders to sell these assets short until they reach an extreme on the low end.

So, for example, as Amazon shares have moved up several hundred percentage points in the past few years, many traders bought the stock who wanted to ride the uptrend. Now that this trend has stopped, they have no reason to own the stock, and they will likely sell into strength. Once these traders have finally exited the market those left holding the stock are those who believe in its longer term value, and the stock will stop going down.

Second, when stocks fluctuate in price they go from being overvalued to undervalued, back to being overvalued. A company like Mastercard was overvalued at $84/share, and it probably reached a point of fair valuation when it traded down to $70/share on Tuesday. However, I think there is a strong likelihood that the stock will trade down further to a point at which it is undervalued — say, for instance, $60/share, or perhaps even lower.

Third, while these stocks have traded lower, for the most part analysts haven’t abandoned their bullish price targets. While a few analysts have lowered these targets, all of these growth stocks have “buy” ratings from most analysts. This, I think, is bearish. Analysts tend to be bullish generally, and so I wouldn’t wait for these stocks to have an average rating of “sell.” But I do think that we will reach a point where analysts don’t think the stocks are going higher, and where a few analysts put “sell” ratings on them.

Ultimately, the companies I list above, as well as their peers among the large cap growth stocks, tend to be good long term investments. I would even argue that some of these stocks (e.g. Mastercard) offer decent value at current prices. But investing decisions need to be made based both on fundamentals and on market psychology. Right now, market psychology is too bullish, and this means that too many people still own these stocks. The bounce we saw last week can probably be attributed to short selling, and I don’t think it is going to last. When we see investors start to lose their conviction that the aforementioned stocks are worth holding this will signify a good buying opportunity. For now, the best option is to wait on the sidelines.

Disclosure: Ben Kramer-Miller has no positions in any of the stocks mentioned in this article.

More From Wall St. Cheat Sheet: