Outperformance by second tier US retailers is unlikely to last as investor sentiment is now switchin...
Outperformance by second tier US retailers is unlikely to last as investor sentiment is now switching back to large cap growth opportunities, according to Clerical Medical.
James McLellan, fund manager of Clerical Medical American Growth, believes the recent popularity of stocks such as JC Penney and Federated Department Stores was a reaction to cuts in US interest rates and not the beginning of a long-term trend.
He says: "The change in investment strategies was due to the slowdown in the US economy.
"The demand for higher P/E stocks had depreciated in recent months and traditional stocks have benefited as historically they have been interest rate sensitive."
He believes that the cyclical nature of this kind of stock has added to their attractiveness citing the example of JC Penney, whose price fell 55.58% in the three years to the end of March but has returned 7.68% in the 12 months to the same date.
McLellan thinks that further cuts in US interest rates will not drive prices higher as too many question marks remain over the future viability of department stores.
For example, although the threat from internet based companies has retreated it has not disappeared altogether.
He adds: "The easy money has already been made by investors in this sector. It's going to be a tough retail environment over the next six months. Those companies that have proven business models, such as Wal-Mart, Home Depot and Costco, will be the ones to come through. They have a format that appeals to the consumer and have shown that they can grow it."
Alison Wright, an investment manager at Britannic, warns against generalising entirely. While she agrees that the general move towards second tier stocks is probably at an end, she believes that there are still profits to be made in more traditional holdings.
She says: "The rationale that fuelled investors' move towards second tier stocks was based on their much lower valuations. However in terms of P/E multiples, the gap between large cap and second tier has now closed, and the market is now much more difficult to predict."
Wright believes consistent large-cap, low-cost operators such as Wal-Mart will continue to prove a lure to investors as they have yet to disappoint.
Wal-Mart has had no profit warnings over the past year and has a strong mix of core businesses.
The company has returned 10.52% over three years to the end of March, but in the past 12 months the stock has fallen by 8.57%.
Britannic is slightly overweight in the retail sector with holdings in Wal-Mart, Home Depot and Federated Department Stores. Home Depot is seen as having outperformed this year after a disappointing 2000 while Federated was undervalued at the start of the year and is now beginning to lock in some profit, Wright says.
She is expecting that further interest cuts as well as the Bush administrations' proposed tax cuts will boost consumer confidence and spending in these areas.
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