Growth companies – those able to sustain growth not by virtue of a strong economy but because of their ability to innovate and open up new markets – have been in the vanguard of the US stock market’s advance this year.
In the context of recent times, that’s not unusual. Growth stocks may be comfortably in the lead this year, but they ended 2015 and 2017 in a similar position1.
While concerns about rising corporate costs and the possibility of a world growth slowdown have been pummelling stocks this month, Apple, Microsoft and Amazon – the largest constituents of the S&P 500 Index – are still up by more than 50% on average over the past 12 months2.
You only have to look at Netflix’s latest results and the ensuing rally in the company’s shares to see that investors are open to grasping short-term fluctuations in the success of growth companies as opportunities. Having disappointed earlier in 2018, the film and TV content streamer added almost 7 million new customers in the third quarter – 31% more than during the same period last year3.
Proponents of growth investing styles often eschew the traditional distinction drawn between growth and value investing by saying that growth, in fact, creates value. Short term disappointments and share price retracements for secular growth companies should be viewed as buying opportunities.
There’s a lot in that. Even highly rated shares have the potential to become less highly rated if their earnings are growing fast enough.
However, contrarian value investors tend to seek to invest in businesses that are out of favour with the consensus. They would say the market under-appreciates certain sorts of company from time to time and that you can tell which ones they are by looking at factors such as dividend yield or prices versus tangible assets on the balance sheet.
History shows that, over the very long term, the majority of the UK stock market’s returns come from dividends4. It stands to reason then that companies with higher-than-average yields ought to provide investors with an edge.
The problem with that is companies whose shares have high dividend yields and represent good value on paper can remain value plays for a considerable time, especially if their businesses are failing to grow quickly enough to attract more investors.
This year so far, value stocks have been left largely to fend for themselves – value markets too. While the S&P 500 Index in America – despite being deep in the throes of this month’s bout of volatility – is still sitting on a gain this year, the FTSE All-Share Index is down by more than 9%5.
Since the S&P 500 is an index based on the market values of its constituents – much like the FTSE 100 but unlike the Dow Jones Industrials Average – the biggest companies tend to exert a lot of pull.
However, this belies the true picture because plenty of smaller companies have been performing well too6. The truth is momentum has been the strongest factor driving the US market higher – that is to say investors have tended to buy more of the stocks already rising than those lagging behind7.
That’s the worst of all worlds for larger, value companies. Rising oil and commodity prices have provided a lifeline because energy producers and miners often satisfy the criteria of value investors. In the UK lately though, value has become largely synonymous with the domestically oriented companies with the most to lose should the UK’s separation from the EU go badly.
History suggests value is never over as a style of investing but it may remain on the back foot for a while longer. One of the main problems is that valuations haven’t increased as the US market has risen because earnings have been growing quickly at the same time.
There’s not a bubble in stocks as there was in 1999 when technology stocks were soaring, so there’s no urgent reason for investors to switch sides. One day value investing will return to the top, but that might require a good deal more bad news on the world economy and interest rates than we have right now.
Two points arise from all this. Investing passively in a single stock market may provide fewer diversification benefits than expected, as the S&P 500 Index has amply shown this year.
Second, investment strategies with proven success in locating the market winners are worth seeking out. US funds that might have held Apple and Amazon this year but avoided early trade war casualties like Ford Motor Company would be prime examples.
Fidelity’s Select 50 list of favourite funds contains actively managed exemplars of both the growth and value investing traditions. Interestingly, the Rathbone Global Opportunities Fund, which currently has around two thirds of its portfolio invested in the US, counts Align Technology, Amazon and Adobe Systems among its top-10 holdings but not Apple or Microsoft.
The JPM US Select Fund holds large positions in all of America’s big three – Apple, Microsoft and Amazon – along with other familiar tech names such as Alphabet (Google) and NVIDIA.
The Fidelity Special Situations Fund takes a markedly different approach, seeking out unloved companies entering a period of positive change. There’s plenty of value in evidence here, with holdings in Royal Dutch Shell, BP and the US bank Citigroup among the largest holdings.
Growth investing: Growth investors seek the shares of companies where the principal attraction is earnings growth.
Value investing: Value investors actively seek the shares of companies that they believe the market has undervalued.
1 FTSE Russell, 28.09.18
2 S&P Dow Jones and Bloomberg, 24.10.18
3 Netflix, 16.10.18
4 Barclays Equity Gilt Study, 02.06.14
5 Bloomberg, 24.10.18
6 Wall Street Journal, 16.09.18
7 S&P Dow Jones Indices, 01.10.18
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.