Will you profit from the stock market’s ‘seismic shift’?
It’s a force tipped to transform the stock market this year and beyond. What is it, and what does it mean for your investments, asks Richard Dyson
The market is arriving at a turning point that is as significant as the collapse in share prices following the dotcom boom in the early 2000s – or so say a growing number of experienced professional investors. A seismic shift is under way, they argue, in which certain types of shares are about to plunge out of favour. In their place a raft of new stocks will come to the fore.
Investors stand to gain or lose according to how their portfolios are positioned – and the stakes could be very high indeed.
Shares that in the past decade have risen to dizzying valuations, propelled by ultra-low interest rates and a hunt for low-risk, solid returns, might now correct violently. This would bring their share prices back down towards their long-term relationship with the company’s earnings.
Other shares, which have been shunned in the decade since the credit crunch, will now be reappraised as an appetite for risk returns. Their low current valuations, relative to their earnings and prospects, will correct in the opposite direction: their share prices will rise.
This tectonic movement, if it comes to pass as predicted, would be a huge shift from “growth stocks” to “value stocks”. While that may sound technical, it’s being viewed by some as a once-in-a-generation force set to transform markets through this year and beyond.
Here, in the answers to five questions, is everything you need to know in order to understand how your investments could benefit – and how they are at risk.
What are ‘growth’ stocks and what are ‘value’ stocks?
Quoted companies are valued by their shares. HSBC, for example, is priced at £135bn, which is the total worth of all its shares in issue at the current share price of 680p. But is that cheap or expensive? To find out, analysts apply numerous measures in an attempt to gauge a company’s true value. These include looking at the ratio of a business’s share price to its earnings (the price to earnings ratio or p/e), for instance, to see whether it is out of kilter with the long-term norm. The dividend paid relative to share price (dividend yield) is another measure of value.
“Value” stocks tend to be those that the market has, for one reason or other, underpriced relative to their likely prospects or the value of their assets. “Value investors” seek these shares consistently.
The long tradition of value investing stretches back to Benjamin Graham, author of the hugely influential book The Intelligent Investor. His approach was later followed by other investors, including Warren Buffett.
“Growth” stocks have different characteristics. When measured against the same criteria as “value” stocks, they may seem expensive.
But their appeal is that they promise solid earnings growth. They may, for example, be manufacturers of staple goods or cigarettes. And they may have a monopoly in their market area. Demand for these products – and thus the firm’s earnings – should hold up or grow, even when, for instance, the wider economy is faltering.
According to the experts we spoke to, examples of growth stocks in today’s market include Unilever, the maker of Marmite, and rival Reckitt Benckiser, but could even extend to traditionally “defensive”, slow-butsteady firms such as National Grid and British American Tobacco.
Robert Burdett, who chooses funds for F&C Investments, said one definition of a value stock was one trading on a p/e ratio below the market average, while growth stocks were sometimes seen as those growing faster than the market average.
Why does this growth/value distinction matter?
At the root of the distinction is whether a company’s share price reflects the business’s real value. During periods of fear and caution, as in the past decade, the traditional methods of valuing companies are partly put aside. Instead, the markets cherish businesses that seem able to grow their earnings, come what may. Nicholas Kirrage of fund group Schroders is one of those who believe that a gigantic switch from growth to value is under way.
According to his analysis (see graph), “value stocks are more out of favour now than at any point in the past 40 years”. The whole market has drifted to the position where growth is favoured above all else, he said.
His analysis of all major unit trusts investing in British shares shows that 91pc have a “growth” bias. Just 9pc are tilted towards “value” stocks. This shift has arisen as fund managers, acting in concert, have chased the same stocks and types of stock.
In turn, this has exaggerated the divide between “value” stocks and larger swathes of the market (“growth”) where prices are too high.
Why now? What’s triggering the change?
One answer lies in economic factors. These include rising interest rates and higher-than-expected growth.
Guy Monson of Sarasin, a firm that specialises in managing charities’ money, is another seasoned investor who said a dramatic shift was taking place.
For him a combination of Donald Trump’s election – the “Trumpflation effect” – and better-than-hoped-for economic growth from Europe and China is steering the change. He believes the domination of growth stocks, with their perceived low risk and “bond-like” characteristics, is over. “Can these big, defensive growth
‘When the economy improves, it boosts value more than growth’