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Value Stocks to Shine: Banks, Energy and Materials Ripe For Rally

NEW YORK (TheStreet) -- Value stocks are poised to catch the next wave of investor interest as growth plays fall from favor amid a strengthening economy.

Strategists and fund managers say the mature market rally and economic backdrop have set the stage for value stocks to shine, overshadowing sectors that outperformed in the early part of the rebound.

These sectors included consumer discretionary, biotech and internet stocks as U.S. stimulus helped drive momentum investing in markets.

Now, fund managers point to industrials, banks, energy and materials as sectors ripe for a rally.

"Last year was a momentum year, but this year has been frustrating for anyone who was a momentum investor," Federated Investors senior vice president Linda Duessel said in a phone interview.

"So if I'm considering getting into the market and the economy is accelerating, I'd try and buy the value sector as it looks inexpensive."

Duessel also points to the growing valuation gap between small and large cap stocks.

Small caps are 10% more expensive than the S&P and 15% more expensive to their historical norm, according to Deutsche Bank.

In addition, the top 25 stocks with the lowest price-to-earnings ratios span the tech, financials and energy sectors. These stocks have an average P/E of 11.8 times earnings vs. 17.2 times for the S&P without these companies.

"The Fed Philly is a good early indicator of economic activity and it's looking good," Duessel added. "Value typically outperforms during periods of risk-taking and economic growth."

She sees lower-than-expected economic growth in China and U.S. as the two greatest risks to her thesis, but says Chinese authorities are likely to do all it takes to maintain growth while first-quarter U.S. economic data was likely affected by the weather.

The strategist cautions against being rigid in the definition of growth and value stocks -- Microsoft (MSFT) for example, is in the tech sector, which is typically considered growth. But it has plenty of cash on its balance sheet and should be viewed as more of a "stable growth stock", she suggests. Separately, Apple (AAPL) has been classified as a value stock by some analysts, who note it trades below the market P/E at 12 times forward earnings with a strong balance sheet. Others argue that the fortunes of tech stocks are not sufficiently linked to economic growth to class them purely as value stocks.

Palisade Capital Management chief investment officer Dan Veru agrees that bank stocks, industrials and transport names are more attractive this year, given factors such as relative valuation.

"As the U.S. economy is improving it makes sense for biotechs to be subject to profit taking," he said, noting the sector is more insulated from economic swings, with cyclical stocks better placed to benefit.

Fund managers at Ridgeworth Investments and Villere & Co characterize the shift away from growth to value as investors taking profits in sectors that rallied hard.

"Now we're seeing a period of catch up in value names," Ridgeworth's director of asset allocation Alan Gayle said. "And those areas of the market that act like bonds will continue to struggle."

-- By Jane Searle in New York

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