Published on November 5, 2018

With the U.S. economy now in its ninth year of expansion, investors have become wary of growth stocks and their higher multiples. The ongoing market volatility has increased these concerns, but research from Cornerstone Macro suggests that a slowdown in the economy may in fact be favorable for growth companies.

We have always believed that growth stocks belong in any long-term asset allocation. Our logic is simple – over time, companies with steadily increasing earnings should deliver higher returns than slow growing companies.

Nonetheless, many investors avoid growth stocks, fearing they are little more than well-disguised momentum stocks. Those concerns are elevated right now, as the recent market selloff has investors worried the long-running economic expansion is finally slowing down, potentially causing growth stocks to fall faster than more defensive value stocks.

A recent report from Cornerstone Macro argues that the opposite is true. The authors agree with the concerns about a potential slowdown, but they believe that a cooling economy is actually quite favorable for growth firms. Moreover, the authors claim that the traditional risk relationship between growth and value is changing.

As the Market Cools, Earnings Take Priority

According to the Cornerstone report, “History shows that the sweet-spot for growth, cyclically speaking, is the period that follows a peak in economic prospects.” The chart below shows the three phases that typically occur after a peak in economic activity.

Phases of Risk-Off Cycle

The x-axis shows the number of months before and after the economy hits its apex, as measured by the Institute for Supply Management’s Purchasing Manager’s Index (PMI). Citing a recent decline in the PMI following a multi-year peak, Cornerstone argues that the U.S. economy is at the beginning of a sustained period of slower growth. They believe PMI is a leading economic indicator signaling that the long-running expansion is likely to lose steam as the Fed pushes up rates and inflationary pressures mount.

They argue that a slowdown favors growth firms because it is a more challenging environment in which to operate, significantly reducing the number of companies that are able to deliver steadily increasing earnings. And historically, those that are able to do it are almost always growth firms, as they are less sensitive to the state of the macro economy. These companies should stand out from the crowd, which will increase demand for their shares and push up their stock price.

Cornerstone believes the process is already underway. Using the S&P 500 as a proxy for the broader market, they show that breadth (as measured by the number of stocks above their 150 day moving average) has declined since 2016 while the price of the index has steadily risen.

SP500-150 Day MA

Their conclusion is that the gains are driven by a progressively smaller set of growth companies whose share prices are rallying disproportionately.

Structural Shifts Should Continue to Favor Growth

The authors also point out that growth has beaten value over the past decade*, and they argue that the key post-crisis structural shift that has driven this dynamic is likely to continue.

Specifically, consumer debt as a portion of GDP has fallen roughly 20% in the past decade, and the authors believe this is the major reason quarter-over-quarter GDP growth has been materially slower during the current recovery than during other expansionary periods. The present growth rate is roughly half the rate from 1980-1999, and roughly 75% of the growth rate from 2000-2008.



Reduced GDP growth has translated to slower top line expansion for the broader market, pushing investors toward growth companies. They expect this trend to intensify as the economy slows in the near-to-medium term.

Risk Profiles Are Changing

Perhaps the most intriguing component of Cornerstone’s research is their claim that the traditional risk relationship between growth and value has changed.

Using beta as a proxy for risk, the authors show that the relationship between P/E and beta has essentially reversed itself over the past 15 years. Specifically, high P/E stocks now have a low beta and vice-versa.

Beta Profiles Reversing


Cornerstone’s analysis offers an interesting perspective that combines conventional wisdom with a contrarian view. They agree with the prevailing sentiment that the current economic expansion is likely to slow down, but they have the uncommon belief that such a change would actually be good for growth stocks.

James Callinan, CFA

Chief Investment Officer – Emerging Growth


James Callinan, CFA

Chief Investment Officer – Emerging Growth

James Callinan, CFA

Chief Investment Officer – Emerging Growth

Jim Callinan was the Co-Founder & Chief Investment Officer at RS Investments. He also co-founded the RS Growth Group LLC in 1996 and managed the RS Emerging Growth Fund from 1996 until 2010. In 1999 Mr. Callinan was named Morningstar’s Domestic Stock Manager of the Year.*

He served as portfolio manager for the Putnam OTC Emerging Growth Fund from 1994 to 1996 and began his career at Putnam Investments as an equity research analyst in 1987. He joined Osterweis Capital Management in 2016 and brought with him the Emerging Growth Partners, LP, a concentrated small cap growth strategy he founded at RS in 2006.

Mr. Callinan is a member of the Weatherbie Capital Advisory Board.

He is an equity owner in the firm and the Lead Portfolio Manager for the emerging growth strategy.

Mr. Callinan graduated from Harvard College (B.A. in Economics), New York University (M.S. in Accounting) and Harvard Business School (M.B.A.). Mr. Callinan holds the CFA designation.

*Morningstar Managers of the Year are determined by a combination of qualitative research by Morningstar’s manager research analysts; risk-adjusted medium- to long-term performance track records; and performance in the calendar year.

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Emerging Opportunity Fund Quarter-End Performance (as of 3/31/24)

Fund 1 MO QTD YTD 1 YR 3 YR 5 YR 7 YR 10 YR INCEP
OSTGX 4.46% 12.10% 12.10% 26.31% -0.87% 13.72% 15.68% 12.93% 14.65%
Russell 2000 Growth Index 2.80 7.58 7.58 20.35 -2.68 7.38 8.40 7.89 10.29
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Gross/Net expense ratio as of 3/31/23:1.25% / 1.13%. The Adviser has contractually agreed to waive certain fees through June 30, 2024. The net expense ratio is applicable to investors.

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The charts and graphs included in this article were all provided by Cornerstone Macro.

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Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.


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