The past 6 weeks the broad stock market has been relatively flat, but not every sector within the market is acting the same. There has been a definite shift from high growth/momentum stocks to more value oriented stocks inside the market. Investment strategists call this a change in “market internals”, and we are definitely having a defensive shift internally. The chart below shows how the utility sector (orange line) is outperforming the biotech sector (green line) this year and is indicative of the shift taking place in market internals right now:
Slow growth utilities don’t often outperform high growth biotech stocks, but this year they are as investors are cashing in on last year’s winning “momentum” trades and moving to safer sectors of the market. This rotation is taking place as investors digest a confusing first quarter in the economy and weaker corporate earnings. The media is sensationalizing this rotation out of momentum stocks daily, but what really is a momentum stock? Below are the characteristics of a momentum stock:
· The momentum company has high rates of sales growth
· Often these companies show little to no earnings (they reinvest into growth initiatives)
· They tend to have very high valuation multiples (often they trade on multiple of sales)
· Investors deem these growth rates rare in the marketplace and buy the stock up to increasingly higher prices
Let’s look at a high growth company/stock that falls into the “momentum” category. The company is Amazon.com and below are its financial metrics:
· Sales growth rate in 2014 is 22% year/year
· Earnings growth rate is 123% year/year
· Price to earnings valuation multiple is 227X earnings
· Prior to the 1st quarter the stock had run from $250 to $425 up 70% in 9 months
Now let’s look at a value company/stock that investors are rotating too in this current market. The company is Apple Inc. and below are its financial metrics:
· Sales growth rate in 2014 is 6% year/year
· Earnings growth rate is 10% year/year
· Price to earnings valuation multiple is 13X earnings
· Prior to the 1st quarter the stock had run from $425 to $500 up 17%
One stock (Amazon) was a momentum stock in 2013, and the other (Apple) was a value stock. In the first quarter no two stocks represent the abrupt investor shift from growth to value than these two. See the year-to-date chart of the two stocks below:
The rotation out of high growth, high valuation, and momentum stocks has been going on for several weeks now and could have more to go. Markets usually extend a trend (or rotation) longer than investors anticipate. For now Gradient Investments would prefer investors allocate new equity dollars into stocks that have the following metrics or themes:
· Reasonable valuations (PE ratios of 15X or less)
· Larger market capitalizations
· Stocks that pay investors a dividend
The Gradient 50 Portfolio owns blue chip dividend paying stocks that have these characteristics. The G50’s return performance is holding its own this year. The Gradient 33 Growth Portfolio owns positions that fall into the high growth/momentum category and is giving back some of the strong performance it experienced last year.
Later this week two very important economic data points will be reported. They are U.S. GDP and Non-Farm Payrolls (a measure of job growth). These two reports will give investors a gauge of how the economy is doing this year. Below are the expectations for GDP and Unemployment:
· On Wednesday GDP is reported and expectations are for Q/Q change of 1.1%
· On Friday Non-farm Payrolls are reported and expectations are for an increase of 215,000
We’ll be watching these metrics closely to gauge the continuing recovery of the economy. We’ll also be analyzing the remaining 1st Quarter earnings report to gauge the health of corporate America. At the end of the day, market fundamentals will drive stock prices and the fundamentals are determined by the health of the economy and the profitability of the companies that operate within that economy.
As of April 28th, 2014:
Dow Jones US Moderately Conservative Index is up 1.96% (TR) for the year
S&P 500 closed at 1,869.43 up 1.76% for the year
U.S. 10 year Treasury Futures are yielding 2.68% down 0.29% for the year
WTI Crude Oil futures closed at $100.96 up $2.26 for the year
Gold closed at $1,297 per ounce up $93 for the year
To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to the Gradient Investment team.