The move to value

The most recent Merrill Lynch Fund Managers survey found that there had been a significant swing from growth to value. In April, a net 40% of managers believed value stocks would outperform growth stocks over the next 12 months, three times the level in March.

The move to value


This is part of wider nervousness over the lengthy outperformance of smaller and mid capitalisation stocks, and also of sectors such as technology and biotechnology. Valuations, in some cases, had started to look well ahead of realistic growth prospects. Although the most recent US earnings season saw around three-quarters of companies beating expectations, in some cases these expectations had been lowered ahead of time, and some bellwether companies disappointed – notably among the technology companies. 
Michael Hartnett, chief investment strategist at BofA Merrill Lynch Global Research said that investors were increasingly toning down their bullishness on US growth stocks and their bearishness on emerging markets. 
Mega cap has lagged over the past year. Partly this is structural – the real beneficiaries from an improving economic environment are unlikely to be the unwieldy large caps with their globally diversified earnings, but the smaller domestically focused companies. However, there is an increasing groundswell of opinion that this has gone too far and the difference in valuations is too great relative to growth prospects and earnings potential. 
Small and mid cap stocks have outperformed the FTSE 100 over almost any time period. However, over the past month, the FTSE 100 has been around 3% ahead. Small and mid cap fell around 2%, while the FTSE 100 rose 1%. While it is dangerous to extrapolate a long-term trend from one month's numbers, it does suggest that markets may have hit an inflection point. 
A number of the 'recovery' funds have done well in this environment, such as those from Schroders and Jupiter. Funds such as the Franklin Blue Chip fund and fund groups that prioritise quality, such as Aberdeen, have also done well. In contrast, the mid cap-focused funds lie firmly at the bottom of the performance tables. 
Another question is whether active managers can continue their lengthy run of outperformance in this environment. 2013 was an outstanding year for active managers, with many significantly ahead of their benchmarks. However, if the market moves to favour larger capitalisation stocks, the performance of index trackers may start to outstrip active funds. 
There are a number of things that may thwart this trend. There may be stronger momentum in earnings and investors may finally be convinced that many growth companies can make the punchy profits that are predicted for them. This is particularly the case if stronger corporate investment comes through. Equally, M&A activity – as has been seen in the pharmaceutical sector – may boost certain parts of the market. 
However, investors who have ridden the strong performance of growth stocks, particularly those in the small and mid cap area would do well to be wary in this environment. It seems that the market may be on the cusp of a change in sentiment and the type of portfolio that has garnered strong returns over the past year, may not be appropriate from here.   



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