Market strategists and advisers are closely watching the equity markets for what may be a fundamental shift in favor of large-cap and growth stocks.
Year-to-date through Aug. 31, the Russell 1000 Growth Index had climbed 8.15%, trouncing the Russell 1000 Value Index, which had gained 2.45%.
Meanwhile, the Standard & Poor’s 500/
Citigroup Growth Index last month finally edged past the Standard & Poor’s 500/
Citigroup Value Index. Year-to-date through August, the growth index had added 5.88% versus 4.54% for the value index.
“I expect growth will be the dominant style — and large growth in particular — over the next 12 to 18 months” or longer, said Bob Rowe, co-founder of Enhanced Investment Partners LLC of Chicago and a broker with
Raymond James Financial Services Inc. of St. Petersburg, Fla.
To be sure, this isn’t the first time in recent years that there’s been talk of a large-cap-growth rally. But those rallies never quite materialized.
Déjà vu
Indeed, strong U.S. economic growth would benefit small-cap stocks, and lower interest rates would provide a much-needed boost to the financial sector, which is an important component in value indexes, observers said.
For the most part, advisers are not making wholesale shifts in how they allocate portfolios.
Howard Johnson, a principal in Johnson Scannell & Associates, a Bellevue, Wash., office of Minneapolis-based
Ameriprise Financial Services Inc., normally has about 60% of a stock portfolio in value stocks and 40% in growth.
“Now we’re about evenly split between growth and value,” he said. “We’ve been figuring that growth has got to come back some day.”
Mr. Johnson also has been letting his maximum 10% small-cap exposure “drift down” below that level.
Meanwhile, Mr. Rowe, who manages about $250 million, began allocating more heavily toward growth about a year ago.
Today, small-cap value accounts for his smallest allocation, he said.
“We tilt portfolios, so we’re always represented in all four [areas] — small growth and value, and large growth and value,” said Mr. Rowe, who offers a style overlay service to other advisory firms.
Even so, the nascent large-cap-growth rally may have some legs on it, observers said.
As the markets have fluctuated over the past three months, “growth led value, and big [stocks] led small [stocks]. It’s been pretty dramatic,” said Bob Doll, vice chairman and chief investment officer for equities at New York-based
BlackRock Inc.
“This is the first time we’ve seen several months of this kind of behavior,” said Jim Swanson, chief investment strategist at MFS Investment Management in Boston.
Solid story
Observers say that the fundamentals and underlying trends favor larger growth stocks.
At the end of last month, the average stock in the Russell 1000 Growth Index traded at 20 times expected earnings over the next year, versus 26 times since 1987. At the end of 1999, its average p/e ratio topped 52.
Barry Mendelson, managing partner at Capital Market Consultants LLC in Milwaukee, whose firm builds managed-account platforms and provides research on market trends, has been telling clients for two years to be wary of overweighting small-cap and value stocks.
“We have started to see this reversion to the mean,” he said. For the past five to six years, large-cap-growth stocks have “basically been ignored,” Mr. Mendelson said.
One catalyst for the style shift “is a recognition that earnings growth in the U.S. has slowed noticeably,” Mr. Doll said. With fewer companies growing at a double-digit pace, growth stocks are more attractive, because “earnings are scarce,” he said.
The capitalization question is an issue of quality, Mr. Doll said.
“In a period of uncertainty, people want higher quality and better balance sheets, so that pushes them up in capitalization,” he added.
Another catalyst is the percentage of earnings coming from outside the United States, Mr. Doll said. Large multinationals have an advantage there.
“Those [foreign] earnings are holding up better,” Mr. Doll said.
Also helping the shift toward larger growth stocks is the fact that the “bitter memories” of the technology bust of five years ago finally are fading, Mr. Swanson said.
Donald Hodges, co-portfolio manager of the Hodges Fund and founder of Hodges Capital Management Inc. in Dallas, has been making the shift over the past few years. In 2002 and 2003, his all-cap fund, with $720 million in assets, was 70% invested in small- and mid-caps, he said, but now that weighting is reversed.
Mr. Hodges’ bottom-up stock picking has taken him to large
companies that are doing well, he said.
Large-caps should help skittish investors “sleep at night,” Mr. Swanson said. Advisers didn’t have that option in the late 1990s when large-caps were overpriced, he said.
“It’s just the reverse now, with large companies having higher earnings, better margins and better balance sheets” than smaller companies, Mr. Swanson said.
