Important information: 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.
For several months now the stock market’s underdogs have been giving the elite a bloody nose.
Since October last year it has been small companies in unfancied sectors that have been making the biggest strides while large companies in heretofore fashionable areas like tech and consumer staples have followed behind.
This is the so-called cyclical rotation that’s has become the recent big theme in stock markets. Long-predicted, it has seen many companies with cheap valuations fall back into favour at the expense of those whose price looks expensive when compared to their earnings.
To illustrate the rotation, consider these numbers from Dimensional Fund Advisers, cited in the Financial Times this week. US small-cap value stocks returned 76.8% in the six months to March 31, compared to just 14.4% made by large-cap growth companies. That’s an outperformance by small-cap value of 62.4 percentage points, the largest for any rolling six-month period since the first half of 1943, Dimensional said.
A similar, if not quite as extreme, effect can be seen in the UK. Fidelity Special Situations is a fund which specialises in under-valued British companies, with a skew towards small and medium-sized firms. It had been suffering a period of poor performance until November last year but the turnaround since then has been stunning. Since then the fund has returned some 43.6% compared to just 24% (just!) for the FTSE 100 index of the largest UK companies. Please remember past performance is not a reliable indicator of future returns.
The growth-to-value inflexion point is not hard to spot in hindsight. It came in late October when it became clear that vaccines against Covid-19 worked and could be rolled out ahead of predicted timelines. As consumer and business confidence has returned, and lockdown restrictions have been lifted, economic data has improved, reinforcing the sense that undervalued cyclicals which do most of their running as economies pick up can carry on their momentum.
But there are also reasons to suspect that the growth-to-value rotation has its limits, too. Firstly, the apparent economic surge we are seeing may not last. It has been helped by both fiscal and monetary emergency measures which may subside in the months ahead. The Bank of England and US Federal Reserve have each hinted they are ready to act if they believe the economy is running too hot, while government measures such as the furlough scheme in the UK or the relief cheques sent to households in the US are time-limited.
Cast forward to a year’s time - when annual growth figures are no longer being compared to the early depths of the pandemic, as they currently are - and the economic picture is likely to look more mixed. Any rise in unemployment after the end of the furlough scheme will show in the statistics and any temporary boost from lockdown savings being spent will have ended.
Meanwhile, the rise in yields for low-risk assets like benchmark government bonds appear to have stalled for now. As inflation expectations rose after November last year, so did the return demanded by the market to buy Treasuries and gilts because it could expect to see the value of its capital eroded more quickly by rising prices. This hurt the valuations of high-quality growth companies, helping the rotation.
Now, however, those rising yields appear to have plateaued still some way short of the level they were as recently as 2019. If the inflationary pressures currently building in the economy ebb back from here this may be the ceiling for government bond yields in the medium term, and the case against high-quality growth will weaken again.
Five year performance
|(%) As at 2 June||2016-2017||2017-2018||2018-2019||2019-2020||2020-2021|
|Fidelity Special Situations||24.4||7.5||-7.5||-17.4||41.2|
Past performance is not a reliable indicator of future returns
Source: FE, total returns in GBP terms as at 2.6.21
Important Information: Investors should note that the views expressed may no longer be current and may have already been acted upon. The Fidelity Special Situations Fund may invest in overseas markets, so the value of investments could be affected by changes in currency exchange rates. The fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund may also use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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