Fault Lines Revealed

If global economic recovery is sustained, there will be repeated assaults upon the citadels of large-cap growth.
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An abortive coup attempt on the part of value last week was put down ruthlessly by the reigning forces of growth. But the uprising revealed the deep fault lines that lie beneath an undemocratic market, one in which prosperity has been shared among only a favored few. If, or when, change takes place in the economic conditions that have brought about this narrow result, the result itself is likely to change. If global economic recovery is sustained, there will be repeated assaults upon the citadels of large-cap growth by downtrodden asset classes such as cyclicals, foreign equities, small caps, REITs and commodities.

It was asserted here

last week that the superior record of growth investing over value in recent years can properly be described as a five-year creep topped by a one-year crescendo. Such style-defined indexes as

Russell 1000 Growth

and

Value

and

S&P BARRA Growth

and

Value

, as well as similar splits such as

Morgan Stanley's

consumer and cyclical indices, support this description. Let's take this as data in search of a hypothesis and make up some words to fit the music.

Growth stocks eked out steady performance increments over value between 1993 and 1998. There was little variability around this trend and so, by its persistence, it began to assume an aura of inevitability. One hypothesis might be that growth -- globally -- was in short supply and so it should have traded at premium wherever it could be found. Another formulation, closely related, might be that interest rates were generally low and/or falling around the world as policy reacted to disappointing growth, so that the discounted present value of distant earnings was higher than it would have been if current interest rates had been higher.

We can be pretty sure that whatifyouactuallyhadalife.com will have monster earnings by the year 2025, and so long as we don't have to forego much in the way of current return while waiting for them to come in, we may as well go for it. When the Russia and

Long Term Capital Management

meltdown panics hit last year, depression fears spread around the globe and prompted interest rate cuts virtually everywhere there are interest rates, so distant earnings looked still better relative to the then-immediate prospects of none at all for existing businesses.

But global growth prospects, as reflected in key market prices -- such as the foreign exchange, interest rate, and stock market trends in Japan, Korea, Hong Kong, Brazil, and Mexico -- have changed dramatically since last year's fourth quarter. Crude oil must be an Internet play: It's up 50% in two months. The implication of these market price trends is that, looking ahead, growth may not be in such short supply as it has been. The relative value of growth may therefore decline, and the appropriate discounts for valuing far distant earnings may rise. This will tend to work to the relative advantage of les sans-culottes of the investment world.

Uneasy lies the head that wears the crown. Value indexes outperformed in February and took another run at it during the week before last. Last Monday it looked as if the ramparts would be toppled. But when such growth stalwarts as

Microsoft

(MSFT) - Get Report

and

IBM

(IBM) - Get Report

posted blowout quarterly earnings numbers, and others such as

Coca-Cola

(KO) - Get Report

and

Procter & Gamble

(PG) - Get Report

beat analysts' expectations, the ragged value rebellion was put to rout.

But look for more such raids in the months ahead. The failed value rallies of 1999 hint that there are a lot of investors out there waiting to harvest narrow gains in order to spread them more broadly at advantageous relative prices. It is conceivable that this might be a tranquil reallocation in which value is bought without growth being sold, but that seems highly unlikely. The circumstances that will make value stocks more attractive will make growth stocks less so: better global economic growth prospects, higher relative prices for commodities, and a generally more democratic global prosperity.

Monetary authorities will then be looking to withdraw liquidity from markets, not add to it, so pricey growth stocks are likely to be used as sources of funds for any significant style reallocation. The burst of margin calls that accompanied the selloff in tech stocks last Monday offers a foreshadowing of the market impact of a vigorous rebound in global growth.

The conviction of would-be value investors is fragile now, easily routed by the counter-attack of the "reliable" growth names. But a more reassuring economic environment -- one in which there is more confidence in Japan's restructuring, stronger legs under the recovery in non-Japan Asia, more conviction in the stability of Latin American foreign exchange and interest rates -- will reinforce the courage of those who would reallocate away from the few names that have worked to the many that have not.

Better global growth is no sure thing, though, for value stocks: Just about the time they get the economic wind at their backs, they may get the

Fed

in their faces.

Jim Griffin is the chief strategist at Aeltus Investment Management in Hartford, Conn. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Aeltus manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at

GriffinJ@aeltus.com.