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Part 3: The end of QE—short term negative for large cap growth?

Marc Wiersum, MBA

Series 7-C—Will the Fed take a bite out of Apple? (Part 3 of 6)

(Continued from Part 2)

The quest for growth

The below graph reflects the outperformance of Morningstar’s large cap growth total return index over large cap value since 2008. This graph captures the same data as in the prior graph, though on a year over year basis as opposed to cumulative basis. In this graph, post-2008 year over year return differentials appear to be very modest—with growth outperforming value by a slim margin since 2012. However, on an accumulated basis, as noted in the prior graph, return differentials are more pronounced, with value outperforming growth over the long run. As noted below, large cap growth has slightly outperformed large cap value since 2012. This article looks at the performance of growth versus value shares in the large cap sector and the implications for equity investors, given the current macroeconomic environment and possibility of rising rates.

For an overview on the four main risk factors for equity portfolio returns, please see the prior series, The end of QE and the Four Most Important Factors for Your Portfolio and Key Strategy: Four Key Risk Factors as the Fed Tapers.

 Large cap sector—growth can be more volatile than value, just ask Time Warner

What the above graph makes clear is that growth investing in the large cap sector can be more volatile than value investing at times—just look at the Dot Com era data .  The above graph is a powerful reminder of how large cap growth stocks can get absolutely hammered when markets hit a frothy peak—and take a long time to come back. The Dot Com era data noted above reflects a boom and bust cycle in large cap growth investing. The graph in the prior article demonstrates that large cap value dominates large cap growth over time. However, there can be times when speculative fervor creeps into large cap growth shares over large cap value shares, as occurred during the Dot Com bubble and could be occurring once again post-2008 crisis. The current S&P 500 price earnings ratio at nearly 20 times is still half the Dot Com bubble of 40 times, and just above the 15 times long-term average. But then again, the macroeconomic data during leading up to Dot Com bubble was spectacular by historical standards–especially investment growth. Current investment and productivity growth data in the US has been terrible, and the current market multiple may be more strongly supported by low bond yields than future economic growth expectations.These are the factors that investors will need to watch very carefully, especially if they think that Apple and Google are rock solid near-term, despite the Fed taper. With a three or four percent handle on the ten year bond yield, the S&P multiple expansion might get a little soft.

To see how Apple and Exxon performed relative to a large cap growth index since 1998, please see the next article.

Equity Outlook: constructive macro view

Despite problems in the Ukraine and China, and despite the modest consumption data in the USA, US labor markets appear to be well into recovery—with the exception of the long term unemployed. From this perspective, it would appear that the US is probably the most attractive major investment market at the moment. While the fixed investment environment of the US is still quite poor, corporate profits and household net worth have hit record levels. Hopefully, all of this wealth and liquidity can find their way into a new wave of profitable investment opportunities, and significantly augment the improvement in the current economic recovery. For investors who see a virtuous cycle of employment, consumption and investment in the works, the continued out performance of growth stocks over value stocks could remain the prevailing trend, favoring iShares Russell 1000 Growth Index (IWF), and growth oriented companies such as Google, GOOG, or Apple, AAPL.

Equity Outlook: cautious macro view

Given the China and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index, IWM, State Street Global Advisors S&P 500 SPDR and Dow Jones SPDRs—SPY & DIA, and iShares S&P 500, IVV. Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index, IWD, such as Wallmart, WMT.

Continue to Part 4

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