Part 4: Mid Caps—why value rallies and growth weakens post Fed taper announcement
Value for the long haul
The below graph reflects the recent outperformance of mid cap value shares relative to mid cap growth shares since the 2008 crisis, with a more pronounced 10% outperformance since 2013. The prior article in this series demonstrates that mid cap value dominates mid cap growth in the long run, though post -2008, growth has been strong relative to value. This article examines the recent strength of mid cap growth shares relative to mid cap value shares in the context of the Fed taper and the implications for equity investors.
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Yellen’s bombshell–will Fed taper cool mid cap growth versus mid cap value?
As was the case with large cap growth versus value shares, mid cap shares have also been beneficiaries of the post-2008 appetite for growth shares as the economic recovery improved. However, as the Fed taper is rolled out over the course of 2014, interest rate jitters could put an end to this trend, as has been the case since March 23. The sell off in growth is reflected in the seconf graph in the first part of this series. iShares Russell 2000 growth index, IWM has suddenly underperformed iShares Russell 2000 value index, IWD, by approximately 3.0% since the taper was announced. The last week has seen a significant hiccup in growth versus value. Is this just a blip, or the beginning of a trend? Growth and momentum investors may be getting nervous. Investors will need to watch these value and growth indices very closely. While Fed Chair Yellen’s comments suggested that short term interest rates would stay low for some time, the market is still concerned about a sell-off in the longer end of the curve, which could hit the overall market, and perhaps shares that have seen recent share price acceleration.
The economic outlook—conducive to mid cap growth, or simply speculative froth?
The four recent macroeconomic series noted below have described the US economy in considerable detail, painting a supportive picture for ongoing economic recovery, though also underscoring risks for continued double digit equity returns:
1) US Government Spending: As noted in a prior series on the US macro economy, the US government is back on budget, which has taken some pressure off of deficit spending.
2) Labor Markets: As noted in a prior Series on US employment data, labor markets have picked up dramatically since 2008.
3) US Consumption: As noted in a prior series on consumption data, US consumption is at a good level, though has flat lined since 2012—additional overall consumption growth is not likely.
4) US Investment: As noted in a prior series on US investment data, the investment recovery is in place, though is recovering at a tepid pace, and without improvement in this area, get ready for higher taxes. Implications for equities are mixed.
To see how mid cap Chesapeake Energy, CHK, is faring versus its mid cap value indices, please see the next article.
Equity Outlook: constructive macro view
Despite problems in the Ukraine and China, and despite the modest consumption data in the USA, US labor markets appear to be well into recovery—with the exception of the long term unemployed. From this perspective, it would appear that the US is probably the most attractive major investment market at the moment. While the fixed investment environment of the US is still quite poor, corporate profits and household net worth have hit record levels. Hopefully, all of this wealth and liquidity can find their way into a new wave of profitable investment opportunities, and significantly augment the improvement in the current economic recovery. For investors who see a virtuous cycle of employment, consumption and investment in the works, the continued out performance of growth stocks over value stocks could remain the prevailing trend, favoring iShares Russell 1000 Growth Index (IWF), and growth oriented companies such as Google, GOOG, or Apple, AAPL.
Equity Outlook: cautious macro view
Given the China and Russia-related uncertainties, investors may wish to consider limiting excessive exposure to broad equity markets, as reflected in the iShares Russell 2000 Index, IWM, State Street Global Advisors S&P 500 SPDR and Dow Jones SPDRs—SPY & DIA, and iShares S&P 500, IVV. Accordingly, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index, IWD, such as Wallmart, WMT.