Equities  

Equities rotation offers real bargains

This article is part of
Mid-Year Review - July 2014

In the last few months we have witnessed a rotation in global equity markets, meaning that growth stocks which investors had been keen to snap up last year have recently fallen out of favour.

In the past few months we have witnessed a rotation in global equity markets, meaning that growth stocks which investors had been keen to snap up last year have recently fallen out of favour.

But what caused this trend, and what does it mean for the remainder of this year?

Equity markets enjoyed stellar performance in 2013, driven by stronger economic data and central bank support. Newly-confident investors poured approximately $140bn (£82.3bn) into US stocks alone, having withdrawn roughly $260bn from equities during the previous four years.

They invested much of that money into good quality, large-cap stocks with strong growth prospects such as Disney or MasterCard.

Growth stocks

Some investors also chased gains in more speculative internet and biotechnology growth stocks such as Twitter and Celgene. This trend developed around the world. Chinese internet stocks, such as Tencent and Baidu for example, also soared in value.

In March 2014, however, the new head of the US Federal Reserve, Janet Yellen, suggested that interest rates could begin to rise six months after the end of quantitative easing.

Her hawkish tone spooked markets. The equity sell-off that followed was led by speculative growth stocks, and to a lesser extent quality growth stocks, which had performed well.

Investors flocked to defensive and unloved value stocks to reduce risk. Thus, companies that had performed relatively poorly, and which had the lowest analyst ratings and the highest interest from short-sellers, have recently performed best.

Taking a medium-term view on our investments, rather than following ‘what’s hot’, it can be argued that the recent rotation is simply a temporary correction.

While some of the highest-flying stocks, particularly in the biotech and technology sectors, have become expensive, there is little to suggest that a bubble has developed among growth stocks.

Moreover, many attractive companies in the technology and consumer discretionary sectors have sold off indiscriminately, offering a good buying opportunity today.

It is important to note that many quality growth companies retain their attractive fundamentals, including rising profits and cashflow generation.

Investors can exploit the share price weakness to add to positions in the likes of quality growth companies such as Gilead Sciences, Google, Estée Lauder, Priceline.com, Facebook, Visa and MasterCard.

Each of these businesses has a strong market position, and is set to deliver profitable growth in the coming years, supported by secular tailwinds.

Take the biotech business Gilead Sciences. Unlike some of its more speculative peers, it has a visible earnings-growth trajectory, supported by the recent release of Sovaldi, a breakthrough hepatitis treatment that has just become the fastest-selling drug launch in history, with more than $2bn in revenue in its first quarter.

Sovaldi is an expensive treatment, but with more than 3.2m people in the US with hepatitis C, the drug addresses a large and previously unmet medical need. On current forecasts, Gilead trades on a 2015 price/earnings (p/e) ratio of 10.5x, which is not expensive.