Growth Trade Poised to Fizzle in Recovery Where Stock Market Goes to Value
The strongest sign the U.S. economic recovery is accelerating may be coming from the stock market.
Rising retail sales, consumer confidence and industrial production are helping propel investors toward U.S. value stocks and away from growth stocks, which lose favor when prospects for economic and revenue expansion are strong. The Russell 1000 Value Index, which includes companies that are cheaper than market averages, rose 7.7 percent in December, the highest relative to the Russell 1000 Growth Index since August 2009.
“Labor markets are stabilizing and even gradually improving,” and companies “will start spending more of the liquidity they have,” said Patrick Moonen, senior strategist in The Hague, Netherlands, at ING Investment Management, which oversees $511 billion. While “we were overweight growth stocks for the second part of 2010,” his team now is reversing that bet because “better economic news and strong earnings are elements that drive value outperformance.”
Optimism about the economy has been strengthening since last month. The Conference Board’s index of leading economic indicators rose 1 percent in December, the sixth consecutive increase, and its gauge of consumer confidence jumped in January to the highest level since May 2010. Manufacturing expanded in December at the fastest pace in eight months, according to data from the Institute for Supply Management in Tempe, Arizona.
Retail sales also improved, hitting a record $380.9 billion last month, surpassing the previous peak in November 2007, based on Commerce Department figures. The gains spurred a 3.2 percent annual expansion in gross domestic product during the fourth quarter, according to Commerce Department data released Jan. 28. The increase was the most since the first quarter of 2010, when the economy expanded 3.7 percent. The Standard & Poor’s 500 Index rose 0.4 percent to 1,281.80 at 11:32 a.m. in New York.
Growth stocks in the U.S. have “dominated value for well over the last year, hardly a surprise given investors’ preference for emerging markets to domestic exposure,” Graham Bishop and Ian Richards, equity strategists at Royal Bank of Scotland Group Plc in London, wrote in a Jan. 12 report. “But as domestic concerns subside and valuations become stretched, we expect investors to switch into the ‘value’ catch-up candidates and out of the recent ‘growth’ winners.”
David Schick, a retail analyst at Stifel Nicolaus & Co. in Baltimore, developed a gauge that reflects the shift in sentiment. The Walmart Amalgamated Leading Economic Indicator, or Walei, created in December 2009, predicts the performance of Wal-Mart Stores Inc. shares relative to the S&P 500.
Comprising eight macroeconomic indicators, including existing home sales and gasoline prices, Walei rises when economic conditions worsen or when inflation accelerates, as gasoline and some food costs have been doing. Both circumstances tend to attract customers to the retailer’s discount prices.
Walei, which has ranged from minus 16 to plus 10 since 2002, according to Schick’s calculations, rose to 7, an 11-month high, in November -- a level consistent with outperformance for Wal-Mart, which gets three quarters of its sales from the U.S.
Rising prices are “part of things getting better,” Schick said. “Consumers are slowly coming around to the point that we may not be in recession.”
While the U.S. emerged in June 2009 from the deepest slump since the 1930s, 88 percent of respondents in a Stifel Nicolaus survey released Jan. 18 said it hasn’t ended yet. Even so, the survey showed the highest plans for net discretionary spending since October.
Outpace Growth Stocks
Wal-Mart is starting to outpace so-called early cyclical growth stocks such as Tiffany & Co. after lagging behind in 2009 and 2010, Schick said. So far this year, the Bentonville, Arkansas, company has risen about 5 percent after falling about 4 percent between Dec. 31, 2008, and Dec. 31, 2010. Shares of the New York-based luxury-jewelry retailer have dropped almost 8 percent after more than doubling between 2009 and 2010.
Tiffany is in the Russell growth index and is trading at an average of 20 times estimated earnings, according to data compiled by Bloomberg. That compares with 9.4 times for JPMorgan Chase & Co., which is in the Russell value index, and 14 times for Wal-Mart. New York-based JPMorgan posted a record $4.83 billion profit on Jan. 14, buoyed by $2 billion in reserves added back to earnings as credit quality and the U.S. economy improved. Shares in the second-biggest U.S. bank by assets have climbed 5 percent this year after a 1.8 percent gain in 2010.
The momentum is coming partly from record-low benchmark interest rates, about $2 trillion in securities purchases by the Federal Reserve and a rebound in company spending. Bookings for capital goods such as machinery and communications gear, excluding aircraft, climbed 1.4 percent in December after a 3.1 percent gain in November.
“You broadly have a set of economic data that are showing some incremental improvement,” said Keith Hembre, chief economist and chief investment strategist at Nuveen Asset Management in Minneapolis. “At the same time, you’ve got the Fed continuing to pump liquidity into the markets.”
Policy makers are sticking with their plan to buy $600 billion of Treasury securities through June, the Federal Open Market Committee said Jan. 26 in a statement after a two-day meeting in Washington. The pledge reflects the need for more stimulus to bring down joblessness, which has remained above 9 percent since May 2009.
‘Five More Years’
Nonfarm payrolls fell in 35 U.S. states last month while the unemployment rate rose in 20, according to the Labor Department. Employers added 103,000 jobs, fewer than forecast, reinforcing Fed Chairman Ben S. Bernanke’s prediction in Jan. 7 Senate testimony that it may take “four to five more years” for the labor market to “normalize fully.”
The Fed also repeated in the Jan. 26 statement its intent to keep the target range for the federal funds rate between zero and 0.25 percent “for an extended period.” Jan Hatzius, chief economist for Goldman Sachs Group Inc., and Michael Feroli, chief U.S. economist for JPMorgan, predict the central bank will hold rates unchanged and not raise them until 2013.
That eventually should boost prices, according to a Bank of America Merrill Lynch Global Research survey, released Jan. 18, of 199 money managers who oversee about $562 billion. Seventy- two percent, a six-year high, predict inflation will accelerate in the next 12 months, compared with 61 percent a month earlier.
The Fed’s preferred inflation gauge, which excludes food and energy, rose at a 0.4 percent annual pace in December, the smallest gain in data going back to 1959 and below the central bank’s longer-run goal of 1.6 percent to 2 percent.
Investors, meanwhile, are focusing on the economy’s slow but steady progress. The Dow Jones Industrial Average, which represents the largest U.S. companies, rose above 12,000 last week for the first time since June 2008. Mutual funds that invest in U.S. stocks ended an eight-month period of withdrawals in the week ended Dec. 21, according to the Washington-based Investment Company Institute.
Last year, people were worried about the economy sliding back into recession, said Royal Bank of Scotland’s Bishop. “There’s certainly much less concern about the double-dip risk now,” providing “a catalyst for stocks that have underperformed.”