From FAANG to value
The FAANG stocks – Facebook, Apple, Amazon, Netflix and Google – were the main driver of the stock market in 2017, defying gravity and confounding regular predictions that they would falter. Stock indices across the world hit multiple record highs, with the tech sector leading the way.
However, there are many who are worried that stock valuations are now looking high. Some fund managers believe there should be a move away from super growth and into value stocks in 2018. Jupiter Asset Management, for instance, warns that if the FAANG five start to appear overvalued, prompting big investors to exit and depress prices, that could spark a correction or downturn. Value stocks would offer some protection from that.
‘Whether institutional investors move their money from growth to value will depend on the risk of an economic downturn, or growth so strong that interest rates rise sharply. Any move away from the current comfortable environment of growth with subdued inflation could make value look more attractive. It may be time for investors to reassess the balance of growth and value in their portfolios,’ says Colin McLean, managing director of SVM Asset Management.
McLean says many traditional value stocks, such as banks, now have to contend with industry challengers and technological disrupters, whereas oil and commodity stocks may be less vulnerable. According to BlackRock, commodity prices and profits have stabilised, the improvement should continue, and the mining sector is still well off its 2011 peak.
Small and beautiful
Small was definitely beautiful in 2017. The bottom 10% of the UK market returned 18.8% last year, according to Numis Securities, while the Alternative Investment Market (AIM) returned 27.4%.
That wasn't what the pundits expected. At the start of the year, it was UK companies which were supposed to be most vulnerable to a Brexit-induced slowdown. While the FTSE 100's big international earners were bound to benefit from the weak pound, smaller domestic stocks would be the losers. In reality, they streaked ahead of the 13.1% return of the all-share index and the 12% rise in the FTSE 100.
According to research from London Business School, smaller companies suffer in downturns, but when growth is above average they outperform strongly. They also prosper when inflation is subdued and interest rates are low — a situation which many see continuing through 2018.
Small stocks may also get less attention from analysts in future. New Markets in Financial Instruments Directive (MiFID) regulations on transparency of research costs may make banks and brokerages less inclined to cover the lower reaches of the market. Passive investors should note that this could mean a greater potential for mispricing of small stocks in an index — for better or worse. Those prepared to do their own deep research may come out as winners, although it should also be remembered that smaller stocks come with higher risks.
MIFID has also given passive investing a boost by forcing full disclosure of manager costs. An analysis by consultancy company, The Lang Cat, found that investors in 13 of 2017's 20 top-selling funds are paying on average 30%, and as much as 85%, more in additional transaction fees than had previously been disclosed to them.
UK small caps shone, but emerging markets (EM) shone twice as brightly in 2017, with the MSCI Emerging Markets Index up 37.3%. Schroders says emerging markets ‘still have relative valuation support’, though it says more caution may be needed later in the year, while Credit Suisse says EM small caps will ‘catch up’ with the large caps, which drove last year's advance.
Individual markets offer even better prospects, according to Morningstar Investment Management with, for instance, Russia offering ‘an implied real return around five times higher than China’.
Hermes says: ‘the global economy, bolstered by continued non-inflationary US and European recoveries, looks set to continue growing into next year’. This means the environment for emerging markets is healthy at present. Current accounts, inflation and growth are healthy in most markets, which with some exceptions (Turkey and South Africa) now have ‘strong defences against foreign rate rises and investor panics’.
But Hermes admits that no market is immune to political shocks, and tests could come from 'the unpredictability in Washington'.
‘Millennials will soon be the dominant generation in the active working population worldwide. They are an increasing focus of politicians and corporate, shaping trends as citizens, employees, consumers and investors,’ says ArchOver, a peer-to-peer lending business, which recently surveyed the savings and investment behaviour of 2000 UK adults.
The apparently penniless 18-35 year-olds are on average investing more than their parents and grandparents (21% invest between £500 and £999 a month). They use social media and digital insight in making their investment decisions, and online platforms for more control over their cash.
‘They’re active, they’re online and they’re more affluent than we thought.’
This has implications for corporates right across the consumer and service landscape, at individual company and sector level, as a new investing force emerges.
ArchOver says: ‘The message for Generation X and the baby boomers is that there’s a lot to learn from millennials about how to invest in the post-crash world. If you came of age in the boom days of the late 80s, you need to look at how your kids are using their money.’