Growth stocks have propelled the stock market higher for the better part of the past decade, thanks to unusually low interest rates and sluggish economic growth in the years before the covid-19 pandemic. Investors’ seemingly insatiable appetite for plays in technology and artificial intelligence has only fueled the fire over the past few years.
But the outlook is different today. Economic growth surged after covid, and it remains stronger than many expected. Markets have dramatically pared back their expectations for interest rate cuts in 2025 amid the threat of higher inflation. Combined with historically high valuations for some of the biggest growth stocks, and some strategists say it’s time to look at a new playbook.
Of course, there have been numerous head fakes when growth stocks stalled or collapsed, only to take off again. Is this time any different?
Value Stocks Lead to Start 2025, but Growth Retains Its Long-Term Advantage
What Are Growth Stocks?
Broadly speaking, growth stocks are companies investors expect to increase their earnings and value. Investors like these names because of their potential to outperform the market down the road, and they’re often willing to pay higher prices and stomach higher valuations to support that potential.
Growth investing strategies are generally considered riskier than value strategies, and certainly more volatile. Value strategies tend to focus on stocks with steady earnings and stable balance sheets that investors believe are trading at a discount compared with their intrinsic worth, providing some cushion when the stock market turns south.
For the last few years, growth stocks have been responsible for much of the market’s blockbuster returns. Mega-cap tech firms like Nvidia NVDA, Microsoft MSFT, Meta Platforms META, and Alphabet GOOGL/GOOG are generally considered growth stocks. Over the past year, the Morningstar US Growth Index has returned more than 26%, outpacing the broader market by a slim margin. The Morningstar US Value Index has lagged in comparison, returning 19.1%.
Will Higher Interest Rates Affect Growth Stocks?
Growth stocks also tend to be more sensitive to changes in interest rates than value stocks. “Conventional wisdom suggests that growth can do well when economic growth is positive but possibly also slowing. And a big part of that is because of the expectation that interest rates can come down,” explains Kristy Akullian, head of iShares investment strategy, Americas, at BlackRock.
Changes in interest rates mean changes in how growth stocks are valued. Analysts use a metric called the discount rate to determine the value of a company’s future cash flows. Higher interest rates mean a higher discount rate, meaning future earnings are worth less than earnings today. Investors expect growth stocks to earn more in the future, which means changes in the discount rate have a bigger impact than they do on value stocks.
Over the past six months, analysts and financial markets have dramatically pared back their expectations for rate cuts from the Federal Reserve in 2025, thanks to sticky inflation and an uncertain policy outlook. Late last summer, market participants expected rates to fall as low as 2.75% by the end of 2025. Today, they generally expect rates to be more than a full percentage point higher at that time.
“There’s been about a 125- or 150-basis-point shift upward in expectations for interest rates, all of which I think is explained by shifting inflation expectations,” says Scott Clemons, chief investment strategist at Brown Brothers Harriman. That shift will have implications for growth stock valuations, he says.
US Growth Stocks Look Overvalued
Whether you look at forward or trailing measures of price/earnings ratios, or Morningstar’s assessment of growth stocks’ intrinsic values, these names look pricey. As of the last week of January, the US growth stocks covered by Morningstar analysts were trading at a 14% premium. At the end of 2024, before January’s stock market jitters, that premium had climbed as high as 20%, while value stocks traded at an 8% discount.
That differential means some strategists, including Morningstar chief US market strategist Dave Sekera, are looking beyond the growth category for opportunities. “Since 2010, growth stocks have traded at this much of a premium or higher less than 10% of the time,” Sekera wrote in his 2025 market outlook. “While investors should maintain some exposure to growth stocks in their portfolio, we think now is a good time to lock in some profits and underweight the growth category to overweight value stocks, which remain at an attractive discount to our valuations and remain market weight core stocks.”
Others say the sheer scope of the valuation and earnings expansion growth stocks have seen over the past few years means the trend is unlikely to continue—another argument for a rotation into value. “It’s hard to see the same type of return profile that you just saw over the last decade from growth,” says Matt Miskin, co-chief investment strategist at John Hancock Investment Management, who says he is increasingly looking to value and mid-cap stocks.
What’s Different About Growth Stocks Today?
Complicating the traditional narrative about growth stocks, interest rates, and stretched valuations are the mega-cap companies that continue to dominate the market. The so-called Magnificent Seven—Nvidia, Tesla TSLA, Meta, Apple AAPL, Amazon.com AMZN, Microsoft, and Alphabet—are widely considered growth stocks. But their seemingly unstoppable earnings growth and a powerful tailwind from AI means they haven’t been as susceptible to rate changes as some of their smaller counterparts.
“What we’ve seen in the last several years challenges conventional wisdom a bit, because the highest-growth companies are also some of the most well-capitalized companies,” says Akullian. “The concept that growth companies need to borrow money to fund capital expenditure and investments in future generations is not quite right” for the biggest players in the market, she says.
The Mag Seven’s powerful earnings growth over the past few years has also helped investors tolerate lofty multiples. “You’re getting three times as much earnings growth from the Mag Seven as you’re getting from the rest of the market,” says Jeff Buchbinder, chief equity strategist for LPL Financial. “That group of stocks should be more expensive.”
Akullian says that while high valuations can certainly be a reason for caution, “part of our preference for staying in large cap, staying in growth, and staying at higher quality is that that’s where we’ve seen those returns be backed up by fundamentals.”
The market seems to have internalized that message. Even with rates at their peak in 2023 and 2024 and valuations climbing, the Magnificent Seven have churned higher while other parts of the market, including value stocks, have languished.
Most analysts don’t expect these stocks to dramatically stumble any time soon, but they say the magnitude of their outperformance may shrink in the months ahead. For some, the sheer popularity of the Magnificent Seven trade has pushed those names into overbought territory and increased the risk for investors.
“So much capital has flooded the growth space; there’s trillions and trillions of dollars tied up there,” says Miskin. “Any movement of that capital into other parts of the market can have a big [impact on] performance.”
Drilling Down on Growth Stocks
The unusual dynamics of the current stock market mean many strategists are reluctant to paint the growth category with a broad brush. Some are emphasizing “quality” growth stocks—those that tend to be more profitable, have steadier cash flows, and see attractive returns. Analysts say a focus on quality is a distinction worth making because stocks that fit the criteria will behave differently than those that don’t when the winds change for interest rates, even within the broader growth category.
For Akullian, low leverage and a strong balance sheet are the most relevant qualities for growth stocks today. “That’s [what] will continue to matter as we expect interest rates to stay high,” she says.
Others point to a sector approach as market dynamics evolve this year, especially given ongoing uncertainty about the impact of tariffs and new developments in AI. “It’s an industry-by-industry question where investors need to be careful about what supply chain they’re in, what segment they’re in,” says Buchbinder.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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