In the past five years, the simple formula for investing success has been to buy small-cap and value stocks. As of Nov. 30, the Russell 2000 was up 41% in the past five years vs. a 1% gain for the Dow Jones Industrial Average and losses of 9% and 23% for the S&P 500 and Nasdaq Composite, respectively. In the same period, the Wilshire Large Cap Value Index has risen 15% while its growth counterpart has fallen 11%. The same pattern is evident in the two-year timeframe as well. But the outperformance of small-caps has shrunk in the past year while growth has started to outpace value. To be sure, the past five years has been littered with
false promises of a big-cap comeback. But it's notable that many of the smarter "gurus" predict the best way to make money going forward will be in big-cap and growth stocks. "Our models continue to indicate that growth stocks are a better value than value stocks, and large-caps will continue to outperform small-caps," Ed Keon of Prudential Securities commented earlier this week. Citigroup's chief U.S. equity strategist, Tobias Levkovich, who made a well-timed bullish call at the October lows, agrees: "Some of our work lately is favoring the mega-cap stocks; in this context, it does appear likely to us that growth stocks should start to come into their own as money flows may begin to switch out of value and into growth." Elsewhere, Bernstein strategist Vadim Zlotnikov struck a similar theme in his weekly commentary, suggesting small- and mid-cap stocks will struggle to match the Street's lofty expectations. "At this point, valuations for mega-cap stocks remain highly attractive on most metrics and growth expectations seem more reasonable and achievable," Zlotnikov wrote. "By contrast, projected earnings growth for the small- and mid-cap stocks may be increasingly difficult to achieve as it will require significant margin expansion from already peak levels amid a decelerating sales growth environment."
|Shifting Tides |
Big-cap and growth stocks are coming back into favor after long-term dominance by small-cap and value
|Source: Baseline |
* performance through Nov. 30
Meanwhile, Bank of America's Thomas McManus, the least near-term bullish among the strategists cited here, writes that "if we were required to commit funds today for a reasonable investment horizon of several quarters or more, high-quality, large capitalization growth stocks still appear attractively valued, in our view." As a long-term observer of Wall Street's prognosticators, my theory has always been that when several of the better gurus start singing the same tune, it usually pays to listen. So, for Wednesday's
"RealMoney" radio show (I'm the substitute host), I reviewed a selection of the big-cap growth stocks recommended by the aforementioned gurus. Each was recommended by at least two of the strategists, and the set is broken down into two groups: momentum and contrarian. If you're a short-term trader and believe in the powers of "window dressing," focus on the momentum group, as these names are likely to remain strong through year end. However, watch out for weakness in the momentum names after Jan. 1, as those same window-dressing managers rebalance their portfolios. Conversely, the contrarian group is likely to remain choppy through Dec. 31 as tax-related selling and money managers' aversion to having losers on the books at year end may keep them under pressure. That said, the contrarian group is likely to outperform in 2006, at least early on, and now might be a good time to start scaling into these name. A quick caveat before proceeding: Just as I used the gurus' collective recommendations as simply a jumping off point, I strongly suggest you do the same with these names. Hewlett-Packard (HPQ): CEO Mark Hurd is enjoying a lavish honeymoon phase and with the stock up 41% year to date, H-P is probably the best big-cap growth name to own for the next 30 days. However, watch out for selling pressure in early 2006 as often befalls the best performers of a given year. Amgen (AMGN) is up 26% this year and has great long-term upside given what one hedge fund source called "exciting new drugs in the pipeline" for osteoporosis and cancer. The source, who requested anonymity, noted that Amgen faces near-term risk to its anemia franchise because of Roche's planned launch of a competitive drug. Amgen is challenging Roche in the courts, claiming patent infringement. I have no insight on when or how the courts may rule, but I do know there's a gap in Amgen's charts from mid-July, when the company reported much stronger-than-expected second-quarter earnings.
Momentum Begets Momentum
|Amgen Disconnect |
Chart watchers believe such gaps are usually filled, meaning that even if Amgen stays strong through Dec. 31, there's a good chance long-term investors will have an opportunity to buy the stock in the low- to mid-$70s, from where the gap occurred, sometime in the first half.
Intel (INTC): Semiconductors have rallied strongly since the October lows, and if big-cap growth is back in vogue, Intel is certain to benefit. With the stock up 14% year to date, I defer to Jim Cramer's "buy on weakness" recommendation, but will note his $28 near-term target is well within reach. Pepsico (PEP): The beverage and snack giant is up 13% year to date and while not absolutely cheap, looks relatively more attractive than Coca-Cola (KO) on P/E-to-growth and price-to-sales metrics. Pepsi also sports a strong looking chart. Exxon Mobil (XOM): Although energy stocks have fallen from grace as oil prices retreated and the political rhetoric heated up, the energy giant is still up 13% year to date. The energy bull market isn't over and the group is likely to have another rally before year end. Looking further out, here's what TheStreet.com contributor Chris Edmonds of Pritchard Capital Partners had to say about Exxon Mobil: It's reasonably priced and stable but the "law of large numbers" makes it hard to grow, especially given environmental/political restrictions on drilling. The company has the cash to create value if they are willing to acquire a major independent. Morgan Stanley (MWD): That this stock is up year to date, even if just by 1%, is telling you something given the pronounced negativity that surrounded Morgan earlier in the year and the fact the Federal Reserve is in a tightening mode. Cisco (CSCO): Despite an impressive balance sheet and relatively attractive valuations -- such as a forward P/E ratio of 15 -- Cisco is down 9% year to date and is decidedly out of favor. Wall Street seems to have lost faith in John Chambers, as evidenced by the But therein lies the opportunity: Cisco could enjoy HP-like moves in 2006 if Chambers is ousted and/or changes his mind about paying dividends. Cisco might also find itself in the crosshairs of activist shareholders, which would likely provide some upside. desultory reaction to Cisco's recent Scientific Atlanta (SFA) acquisition. Johnson & Johnson (JNJ): It's down 3% year to date and has an ugly chart, featuring a series of lower highs and lower lows. At some point money is going to gravitate back to big pharma, but questions remain about the Guidant (GDT) purchase, even at the lowered price. Home Depot (HD): The stock looks cheap on a P/E basis and is now roughly in line with Lowe's (LOW) on PEG and price-to-sales metrics. If Home Depot successfully tests technical support at around $40 that would be a bullish sign, but a (presumably) slowing housing market begs the question: Does that mean less business for the home improvement retailer as the money and desire to fix up the homestead diminishes, or more as people look upgrade current residences vs. moving? IBM (IBM): Big Blue is down 10% year to date but has strong momentum going into year-end. Due to a combination of factors, I believe IBM will prove to be among the best big-cap growth stocks to own in 2006. RealMoney.com contributor Jon Markman outlined the bullish case for IBM yesterday, which I'll summarize: The company has earnings upside potential from exposure to video game consoles and its new z9 mainframe, as well as from recent layoffs and the sale of its PC business. In addition, IBM generates tremendous revenue and profit from recurring sources, which will appeal to fund managers looking for reliable earnings if and as the economy slows in 2006. Technically, IBM has broken out of a long downtrend and could challenge the $115 level if it's able to break through resistance in the $98-$99 range, which appears to be its near-term destination.