Switching From Growth to Value

All good things must come to an end.

For most of 2015, growth stocks far and away have been the outstanding performers in the US stock market.

Almost daily, I delighted in sending you trade alerts to buy winners, like Palo Alto Networks (PANW), Tesla (TSLA), and the Russell 2000 (IWM).

And so they delivered.

The reasons for their impressive gains were crystal clear.

The expectation all year was that the Federal Reserve would raise interest rates imminently. This gave us a perennially strong dollar (UUP).

Thus, one could only direct focus towards companies that were immune from plunging foreign currencies and falling international earnings.

It really was a year to ?Buy American?.

But a funny thing happened on the way to the bear market for bonds. It never showed up.

The final nail in the coffin was Fed governor Janet Yellen?s failure to move on September 17. She looked everywhere for inflation, but only found the chronically unemployed (the 10% U-6 discouraged worker jobless rate).

Not only did we NOT get the rate hike, the prospects are that WE MAY NOT SEE A SUBSTANTIAL INCREASE IN THE COST OF MONEY FOR YEARS!

At this point, the worst-case scenario is for the Fed to deliver only two 25-basis point rises over the next six months, AND THAT?S IT!

This reinforces my belief that the top of the coming interest rate cycle may only reach the bottom of past cycles, since deflation is so pernicious, and so structural.

All of a sudden, the bull case for the dollar, which has been driving our US stock selection all year, went wobbly at the knees.

Europe, Japan, and China are all now in between new quantitative easing and stimulus cycles, giving a decided bud to the Euro (FXE), the Yen (FXY), (YCS), the Yuan (CYB), the Aussie (FXA), and the Loonie (FXC).

New round of QE will come, but those could be months off.

Therefore, I am sensing a sea change in the market leadership. Rushing to the fore are the shares of companies that benefit from flat interest rates and a flagging greenback.

Those would be value stocks.

Value stocks are easy to find. Do any quantitative screen based on low price earnings multiples, low price to book value, and low price to cash flow, and you will find thousands of them. This is what the big boys do.

There is another reason to refocus on value stocks, but it is more psychological than analytical.

We are now into our sixth year in this bull market, one of the strongest in history. Portfolio managers are very wary of paying high multiples at market tops, as many did at the summit of the Dotcom bubble in 2000.

At least if they buy cheap share at market highs they have adequate job preserving explanations for their actions. There is also some inherent built in safety in increasing weightings in companies that haven?t appreciated very much.

I probably don?t know you personally (although I call about 1,000 of you a year), but I bet you don?t have 100 in-house analysts at hand to help you sift through the wheat and the chaff.

So let me do the heavy lifting for you. I?ll distill down the value play to a handful of high quality, high probability sectors.

1) Industrials ? Remember those, the decidedly unsexy, heavy metal bashing companies that you have been ignoring for years? With global businesses and hefty borrowing for capital spending, they do very well in a flat interest rate environment. What?s my favorite industrial? The former hedge fund that made light bulbs, General Electric (GE). They make really cool jet engines and diesel electric locomotives too.

2) Consumer Discretionary ? Finally, people are spending their gas savings, now that they realize it is more than a temporary windfall. A housing market that is on fire is creating enormous demand for all the things owners stuff in their homes, both in new purchases and upgrades. Low rates will keep the 30-year mortgage under 4% for longer. You already know my best names here, Home Depot (HD), and Disney (DIS).

3) Old Technology ? Tired of paying 100 plus multiples for the latest non yielding cloud highflyer? Mature old technology stocks offer some of the cheapest valuations in the market. As, yes, they pay dividends now! I?ll go with Microsoft here (MSFT) as the action in the options market has suddenly seen a big spike.

And what about the biggest old tech stock of all, Apple (AAPL)? I think this will be a 2016 story, and investors reposition themselves to take advantage of the run up to the iPhone 7 launch in a year. But as the recent price action shows, some portfolio managers may not want to wait.

4) Financials ? Are not the first sector to leap to mind when looking for a low interest rate play. Overnight interest rates will remain depressed as far as the eye can see. However, rates at the long end, maturities of five years or more, are rising.

This steepening yield curve is where it really matters for banks, as it allows them to expand their profit margins. On top of that, bank valuations are at the bargain basement end of the market, with many still trading at below book value. Go for Citibank (C), Bank of America (BAC), and Goldman Sachs (GS).

New leadership from low-priced sectors could give us the rocket fuel for a melt up in the indexes into the end of 2015. It could take us right to the low end of my forecast yearend range for the S&P 500 I made on January 6 of 2,200-2,300 (click here for ?My 2015 Annual Asset Class Review?).

After five months of derisking, both institutions and hedge funds are underweight stocks and shy of exposure. As a result this underperforming year has ?chase? written all over it.

Keep your fingers crossed, but stranger things have happened.

GE 10-21-15

HD 10-21-15

DIS 10-21-15

John ThomasIt?s My Turn to Do the Heavy Lifting