In December 1998 growth stocks outperformed value like never before. In December 1999 the market out...
In December 1998 growth stocks outperformed value like never before. In December 1999 the market outdid even that with IT hardware up 27% relative to the All Share. That month proved especially strong because investors could foresee a tightening of rates in the first quarter of 2000 and wished to offload economically sensitive stocks. At the same time, lack of liquidity made pricing reality paper-thin and exacerbated any movements.
The traditional first quarter cyclical rally has become the 'closing of the value gap' and seems an almost cathartic cleansing for the excesses for the final quarter of the year before. It is a peculiarity of the type of market we find ourselves in where rotation is so vicious it can rip a valuation in half before lunchtime and then give it all back the next month.
Rotation can be healthy if it reduces the polarisation of ratings and gives the market breadth. The key factor to determine looking out into 2000, however, is whether the market will rotate into a broad-spread recovery of cheap stocks or whether it will revert to the growth market of most of 1999.
The ratings of the most highly rated sectors in the market certainly contain value risk but there have been some sensible reasons for the levels reached (with December 1999 as an exception to this). There is an element of feeding frenzy with new investors stepping into areas of the market that have already done well. There is also the issue of fundamental underweight positions being addressed but for the most part it boils down to an interesting disagreement between the equity and bond markets.
The equity markets, as a whole, continue to believe in the lowish-inflation, fastish-growth scenario of the new economy and are therefore prepared to reward businesses which demonstrate top-line growth and upward earnings surprises with extensive ratings. This is bound to get over-egged at times because the rush of capital is directed towards such a narrow part of the market.
The bond markets, on the other hand, have their eyes firmly fixed on the 'old economy' and are concerned about a forthcoming boom and the risk of inflation.
It remains to be seen who is correct, but we do believe that the environment remains relatively unchanged. Last year saw a soft landing, which is in itself essentially deflationary because it fails to take out excess capacity (look at the general retailers).
The MPC looks set to punch a hole in any significant upturn in the economy by focusing on the old bug-bears of wage inflation and the housing market without giving weight to what is happening with pricing generally.
We expect the first half of the year (much as with last year) to be difficult and volatile. Many of the cyclical areas have been oversold and if rates peak in the UK at 6.5% then even if the MPC continues to be in contractionary mode there may be net benefits to the industrial side of the economy relative to previous cycles.
Further through the year, however, we expect the bond market scepticism to drift away and be replaced with a return to a belief that the central banks have done enough. A tightening bond market will help to support some of the higher valuations in the market and it will probably return to a focus on secular top-line growth and positive earnings surprises. We are still aware of value risk in the higher-rated sectors, but the market may well be as narrow in 2000 as it was last year.
Dominic Wallington is fund manager at Credit Suisse Asset Management
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