'We've entered the golden age of large-cap growth dominating the market': Expert

Justin Kelly, CEO and CIO of Winslow Capital joins Yahoo Finance's Alexis Christoforous and Brian Sozzi to discuss overall markets and future outlook.

Video Transcript

BRIAN SOZZI: Let's stay on the markets here and not talk about retail per se. Let's bring in Justin Kelly, the CEO and CIO of Winslow Capital. Justin, good to see you this morning. Markets, for the most part, have been on a nice run. What do you make of the market action? And do you think we're due for some short of a-- or we're due for a short-term pause here?

JUSTIN KELLY: Yeah. Well, good morning, Brian. Thanks for having me on the show. Clearly, the market has become more comfortable with the recovery scenario based on an incredible amount of both monetary and fiscal stimulus and some good news on the vaccine front that continues to develop.

So the combination of those two has really driven the rally, which we think is justified. And now there's-- the early rally was led by the growth stocks. And now the value stocks are starting to join in the parade, and that's what has been propelling the market yesterday and today.

ALEXIS CHRISTOFOROUS: Justin, what-- what do you make of the fact that the big tech companies is what's really pushing this rally forward and that we're not seeing a lot of diversity in terms of strength in this market right now? I mean, does that give you pause to think, you know what, there's not a lot of conviction behind the rallies that we have been seeing because it's concentrated in just a few big-name stocks?

JUSTIN KELLY: Right. And the first stage of the rally is almost always characterized by the most powerful and the best companies rallying first. And then over time, there's a catch-up trade with the more value slower growth-type companies. But at Winslow, we believe, actually, we've entered the golden age of large-cap growth dominating the market.

So in many ways, we think this is actually just beginning, because large-cap growth stocks have four major tailwinds that we think are going to propel its leadership for many years to come. The first is that their growth premium to the rest of the market is wider in a slow-growth world. And we are in a very slow global growth world. And the pandemic will slow growth even further.

Number two is that the large-cap growth companies really are on the front foot of innovation as every business retools from the analog to the digital world. And so they're the ones that will be ahead rather than left behind as-- as we shift to the Fourth Industrial Revolution.

And the third tailwind is that these companies are the ones that are producing massive amounts of free cash flow. So the free cash flow margins of large-cap growth companies have increased from 4% to 12% over the last 12 years. And those are the companies that can take that free cash flow and augment their growth through buybacks, dividends, acquisitions, which is more powerful in a slow-growth environment.

And then finally, the fourth tailwind, and somewhat surprisingly, is that the decline in the risk-free rate has a positive impact on growth company valuation, because a bigger component of their discount rate or their valuation is actually the risk-free rate, because they're not perceived to be as risky as, say, value companies, which have a bigger equity risk premium component of their valuation. And so you could actually imagine a scenario where large-cap growth stocks sell at a higher multiple in the future relative to where they were prior to the pandemic because of the decline in the risk-free rate. I mean, the risk-free rate here meaning the 10-year treasury bond. So we think that--

BRIAN SOZZI: Justin--

JUSTIN KELLY: --the growth of large-cap growth investing led by the mega-cap tech stocks is really just getting underway.

BRIAN SOZZI: Justin, what-- what keeps you awake at night on the markets as we look towards the back half of the year?

JUSTIN KELLY: Well, look, we have a lot of stimulus that needs to be maintained until we hand this off till a vaccine and people get more comfortable fully engaging back in the analog world, going to work, et cetera. So we need to see further positive developments on the availability of vaccines. And I'm confident that that will come.

The-- the growth stocks are, you know, maybe due for a little rest here, and the value stocks have a little bit of catch up. But I think the opportunity set over the longer term and into next year really is with the growth stocks. And so you would want to be buying the dips and probably selling the rips in the value stocks.

The one thing that could go wrong for growth stocks is, you know, a big uptick in regulation, which we don't see near term. If anything, the large-cap tech companies and the large-cap drug companies are perceived to be helping society during the pandemic, you know, firstly as a communication mechanism with the tech companies. And secondly, the drug companies are really solving this-- this horrible disease that it is operating.

ALEXIS CHRISTOFOROUS: Justin, what are you hearing from-- from clients right now? Are they more willing to part with cash? I mean, were they sitting on more cash just a few weeks ago, and are they putting more of that back to work into the market now? Or have you not seen that happen yet?

JUSTIN KELLY: Yeah. So our investors sat tight during the pandemic, and so we were encouraged by that behavior. But you've seen a big increase, to your point, in money market funds. So the cash that has gone in and is sitting on the sidelines is-- is substantial, which makes sense because some businesses and so forth are in more difficult situations, and they want to take a wait-and-see approach.

And so as the recovery takes hold, you're going to see a lot of that cash find its way into the market and into financial assets. Now, which financial assets is the question. And I think what we can observe is with interest rates so low, it's just very difficult to get anything more than a return of your money rather than a return on your money.

And so we think that money will continue to try and find homes where it can invest in-- in stocks and equities in companies that can continue to grow their earnings over time. And that earnings is really the big tech consumer and innovative health care companies really, the large-cap growth cohort we're talking about. So that's how we think you can generate returns over the long haul, by buying companies that can grow their business.

BRIAN SOZZI: All right, let's leave it there. Justin Kelly, CEO and CIO of Winslow Capital. Thanks for taking some time this morning.

JUSTIN KELLY: Thank you, Brian.