AEQUITAS

In­vestors should be mind­ful of a po­ten­tial shift from growth to value stocks

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Mar­kets need the FAANGs to show more bite and the BATs to fly again

There is an old mar­ket rule which says that when the in­di­vid­ual stocks or sec­tors that took the broader mar­ket in­dices higher start to tire and roll over then ev­ery­one needs to be care­ful.

And it is an old mar­ket rule be­cause it has stood the test of time.

For ex­am­ple, see how the NAS­DAQ Com­pos­ite in­dex rolled over be­fore the broader US stock in­dices did, just as the burst­ing of the tech­nol­ogy, me­dia and tele­coms bub­ble sowed the seeds of a wider eq­uity mar­ket down­turn in early 2000. A three-year bear mar­ket en­sued in the USA (and the UK, Europe and Asia, for that mat­ter).

NAS­DAQ’S LOSS OF MO­MEN­TUM IN EARLY 2000 HER­ALDED WIDER MAR­KET PROB­LEMS AS TECH BUB­BLE BURST

Dur­ing the 2003 to 2007 pe­riod it was fi­nan­cial stocks, and par­tic­u­larly banks, that made the run­ning. Lo and be­hold they peaked in 2006, as some­one, some­where sensed that too much money was be­ing loaned in too free-and-easy a way and that ris­ing in­ter­est rates would make things a lot more dif­fi­cult for bor­row­ers and lenders alike. Global stock in­dices hit the wall in mid-2007 and bru­tal 21-month mar­ket slump fol­lowed.

ROLL-OVER IN PRE­VI­OUSLY MAR­KET-LEAD­ING FI­NAN­CIALS STOCKS WARNED IN 2007 OF TROU­BLE AHEAD

It re­quires lit­tle imag­i­na­tion to guess which stocks have been tak­ing global bench­mark in­dices higher this time (not least be­cause they fea­ture in so-many pas­sive fund that fol­low their own, smart beta, or cus­tomised in­dex) – the FAANG stocks in Amer­ica (Face­book, Ap­ple, Ama­zon, Net­flix and

Google’s par­ent, Al­pha­bet) and their Asian cousins, the BATs (Baidu, Alibaba and Ten­cent).

In­vestors with ag­gres­sive eq­uity al­lo­ca­tions may there­fore be hop­ing, in the short term at least, that the FAANGs re­gain some bite and the BATs take flight again. Both group­ings have be­gun to flag.

FAANG STOCKS HAVE BE­GUN TO SHOW SOME WEAK­NESS … AS HAVE THE CHI­NESE IN­TER­NET WON­DERS, THE BATS AC­TION RE­PLAY

These are trends which must be fol­lowed closely in the com­ing weeks and months, to de­ter­mine whether it is just part of the sum­mer silly sea­son or a real trend that could have se­ri­ous im­pli­ca­tions for in­vestors’ port­fo­lios.

We al­ready have one po­ten­tial clue. The S&P 500 growth stocks in­dex started to un­der­per­form the S&P 500 value stocks late in the se­cond quar­ter, a marked break from any­thing we have seen for sev­eral years (with the ex­cep­tion of 2016).

VALUE HAS JUST STARTED TO OUT­PER­FORM GROWTH AGAIN

The past is not guar­an­teed to re­peat it­self and such a switch does not nec­es­sar­ily her­ald the end of the bull mar­ket at at the very least it may mean that in­vestors may need to con­sider how much risk they are tak­ing, if they have sub­stan­tial ex­po­sure to growth and mo­men­tum plays via their pre­ferred ac­tive and pas­sive funds.

At first glance it can be ar­gued this has lim­ited im­pli­ca­tions for UK stocks. Tech­nol­ogy Hard­ware may be the fourth-best per­former among the 39 in­dus­trial group­ings which com­prise the FTSE All-Share, but Soft­ware & Com­puter Ser­vices is the worst (thanks to FTSE 100 mem­ber Mi­cro

Fo­cus (MCRO)) and be­tween them they are

tiny, rep­re­sent­ing just 1% of the in­dex’s mar­ket cap­i­tal­i­sa­tion.

CYCLI­CAL OR SEC­U­LAR

How­ever, im­proved per­for­mance from value rel­a­tive to growth could have im­pli­ca­tions for fund se­lec­tion.

It is no­tice­able how value-ori­ented funds, such as Jupiter UK Spe­cial Sit­u­a­tions (0477734) for ex­am­ple, has shown im­proved per­for­mance of late (and in­deed has done so since the UK ten-year Gilt yield bot­tomed some time ago).

Per­haps this lies at the heart of the value versus growth de­bate. Gilt yields may well take their lead from cen­tral bank in­ter­est rate de­ci­sions, with the fol­low­ing im­pli­ca­tions:

If the Bank of Eng­land is tight­en­ing pol­icy be­cause the econ­omy is do­ing well and in­fla­tion is ac­cel­er­at­ing, then in the­ory cor­po­rate prof­its growth should be ro­bust. There is there­fore less rea­son to pay very high val­u­a­tions to get ac­cess to the sec­u­lar growth of­fered by sec­tors such as tech and biotech if a rapid cycli­cal up­turn in com­pany earn­ings is un­der­way.

VALUE-ORI­ENTED FUNDS ARE ALSO SHOW­ING SIGNS OF (OUT)PER­FOR­MANCE

Many mo­men­tum and growth stocks are priced off the earn­ings that they are ex­pected to gen­er­ate some way off into the fu­ture.These prof­its are of­ten val­ued ac­cord­ing to a dis­counted cash flow model, or DCF, which ap­plies a dis­count (or in­ter­est) rate to those earn­ings and dis­counts them back to get a value for them in to­day’s money. The higher in­ter­est rates go, the higher the dis­count rate and the lower the value of those fu­ture earn­ings to­day – some­thing which could af­fect tech stock val­u­a­tions, for ex­am­ple.

Gilt yields (and un­wit­tingly the Bank of Eng­land) may have a big say in the ‘value versus growth’ de­bate and there­fore the di­rec­tion of stock mar­kets over­all, if the change in stock lead­er­ship be­comes a trend, with all of the his­tor­i­cal im­pli­ca­tions this has for head­line in­dices.

Russ Mould, AJ Bell In­vest­ment Di­rec­tor

Ap­ple re­cently opened their £3.5bn Cam­pus 2

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