US stocks and the market regime are changing

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Investors reeling from the stock market turmoil might be happy to see the end of a very shaky January. But the questions keep coming to them in droves and quickly – mostly about the US outlook. Will it move forward in 2022? How vulnerable are star companies to the changing conditions dear to “growth” investors?

It has been unwise to bet against the US stock market for many years and last year was no exception. Wall Street generated a total return, including dividend income, of about 30%, based on the S&P 500 Index.

But the Nasdaq, the tech-heavy index, is now officially in correction territory, falling more than 16% since its peak in November 2021. With more than 220 companies listed in the United States with a market capitalization of more than $10 billion, down at least 20 percent from their highs, it looks like the threat of inflation is starting to bite, along with the US Federal Reserve opening the door for rate hikes and accelerated cuts bond purchases.

The outstanding performance of the United States in recent years has largely reflected the superior earnings performance of its companies. Earnings beat expectations in the first three quarters of 2021 as vaccines rolled out, while the country’s dominant tech sector proved a winner in varying market conditions.

This year, however, many of the often unprofitable tech growth stocks favored by managers such as Cathie Wood of exchange-traded fund Ark Invest, have been shunned by investors, in favor of more stable “old economy” stocks. “, the latter being considered a characteristic of the investment style of Warren Buffett.

Buffett is considered the world’s greatest value investor, while Wood has been dubbed the “Queen of the Bull Market” and a champion of growth investing. The reversal in relative performance between the two is hailed by some as evidence of a broader shift from growth investing to value style investing – a long overdue “market regime shift”.

An improving economic outlook marked by strong U.S. jobs numbers and the belief that the Fed will soon raise interest rates are the main factors pushing investors out of these fast-growing companies that are not still profitable (growth companies) for more price sensitive companies, battered stocks (value).

Readers should keep in mind that while stock markets are skittish, this is far from the first correction since the pandemic hit — in Nasdaq’s case, it’s the fourth. US stocks are more expensive than all others, but there is still much to be said about the defensive qualities of the big tech stocks which account for almost a quarter of the value of the S&P 500. Nevertheless, their high valuations owe much to low rates interest rates, which appear vulnerable to the Fed’s tougher stance on inflation.

Many investors sell their winners and buy the laggards – a well-honed playbook at market inflection points. As one fund manager put it, “We live in a world of erratic returns where factor and style shifts ignite quickly and then burn out seemingly without explanation. This is the kind of bull market that gives you gray hair as we reach so many inflection points in stock market trends.

There is little dispute that investor sentiment has become more fragile amid turbulent economic, monetary and political conditions. The stocks that dominate the market are changing places at an unusually rapid pace. Investors oscillate between reflation, stagflation and resilient growth stocks, with an alarming inconsistency.

But there is also no doubt that the dominance of growth strategies is beginning to decline. As central banks shifted interest rate policy to fight inflation, resilient, long-lived growth assets sold off sharply and investors turned to oil and gas, mining and financials – sectors of the market that could benefit from a strong recovery in earnings.

“It means we are returning to a world of investing that is no longer so binary. We started to see this change last year,” says James Thomson of the Rathbone Global Opportunities Fund, a globally focused fund that has benefited greatly from its exposure to technology stocks and a pro-growth investment style.

Thomson believes the best way for individual investors to manage this change is to ensure their portfolio is balanced. He cut his fund’s tech position from 29% to 20% a year ago by selling the “work from home” stocks that turned off the lights at the start of the pandemic.

Instead, he turned to the banks and “pick and shovel” old-economy stocks — the kind of industrial companies, such as Sandvik and Deere, that do well in times of higher demand.

He also added a few names in retail, luxury goods, transportation and other consumer players like delivery and logistics companies Hermes and JB Hunt, and retailers TKMaxx and Costco, which are benefiting from a reopening economy and the end of what he calls the “socializing recession”. .

A better balance between the two investment styles of growth and value seems sensible. But a modest pullback from “peak growth” doesn’t mean value is now the only game in town.

The United States is the most important stock market in the world and it is where growth is still to be sought. US corporate profits are growing four times faster than those in the rest of the developed world – and many of these companies have competitive advantages that are hard to catch up or replicate. It makes little sense to kick Wall Street out of a portfolio – even if the policy tightening and high valuations argue for an element of caution.

Growth stocks have outperformed value, almost unchallenged, over the past 15 years – so a period of catch-up should come as no surprise to investors. Seize some value opportunities, but beware of “value washing” your portfolio – and leave room for the argument that pure growth strategies will continue to thrive in a world where broad-based growth is still rare .

Maike Currie is head of personal finance and markets content at Fidelity International. [email protected]Twitter @MaikeCurrie; instagram @MaikeCurrie. Immediate family member owns Rathbone Global Opportunities

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