Market Insider

Value stocks to stay in vogue, while momentum fades

Earnings crystal ball
Earnings crystal ball

With the wipeout in growth stocks, many investors turned their attention to big-cap and value names, and the trend is expected to continue for months to come.

"We had seen small caps outperform over the last few years, and now we're seeing signs this relationship is reversing," said Ari Wald, technical analyst at Oppenheimer Asset Management. "Every new high since the start of 2013 was met by a high in the Russell 2000, but really for the first time this April was the first time that it didn't happen."

Analysts expect the momentum shakeout to continue in Internet, social media and biotech stocks, despite Monday's higher market and the gains last week in both the Nasdaq and the small-cap Russell.

Momentum names could also attract buying interest Tuesday, after two big names made headlines after the market close Monday. Netflix announced better-than-expected earnings, sending its stock nearly six percent higher after hours. It is still trading about $90 below its 52-week high of $458, reached in early March.

Bio tech merger machine Valeant joined forces with activist investor Bill Ackman in a merger bid for Allergan. Valeant shares rose sharply, as did Allergan. That could stir up interest in the sector Tuesday.

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"I don't think it's over. If you look at some of the valuations of the sub sectors, they are 25 to 40 percent overvalued," said David Cassese, a director and portfolio manager with BlackRock's Alpha Strategies group. He focuses on consumer, health care and technology sectors.

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Cassese likes big-cap names—Merck, Bristol-Myers and Pfizer in health care, and Microsoft, Intel, Qualcomm and Motorola Solutions are among his tech holdings.

Some analysts expect earnings of big caps, especially those with lower price-to-earnings ratios, to get a boost during reporting season this quarter. Stocks like Coca-Cola and General Electric, for example, both rose after reporting slightly better-than-expected earnings.

Earnings due Tuesday morning include McDonald's, AT&T, United Tech, Travelers, Lockheed Martin, Bank of NY Mellon, Xerox, Illinois Tool Works, AK Steel, Canadian Pacific Railway, and Comcast (CNBC's parent company). Amgen, Gil Sciences, Juniper Networks, VMWare, Yum Brands and Cree report after the close.

Cassese said many earnings reports this quarter are going to be distorted by weather-related factors. "People are going to look through a lot of it," he said.

Analysts are fairly positive on the broader market, despite expectations that the shakeout will continue in smaller-cap and momentum stocks. The IBB iShares Nasdaq Biotech ETF was trading higher Monday at 226, but it is still below its February high of 275, and SOCL, the Global X Social Media ETF was at 18.90 Monday, well below its March high of just under 23.

"If you expect growth to pick up a little bit, and that we're not at the end of the cycle and this has a few years to play out, it makes sense to be in more economically sensitive stocks that have lower P/Es and are more sensitive to an improving economy," said Scott Wren, Wells Fargo Advisors senior equity strategist.

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Wren said he had been hoping for a bigger pullback in the S&P—to the 200-day moving average at about 1,770. That would have provided a good entry point, but he also would add a smaller amount to equity holdings at current levels.

"The momentum situation had gotten out of hand," he said. "One of the ways to make sure you don't make your financial goals is to be loaded up on home run stocks." Wren said one of the warnings that the momentum shakeout was coming was the fact that so many IPOs were coming to market for companies that had no earnings.

Before last week's bounce back, the Nasdaq and Russell were both nearly 10 percent off their highs, close to official correction territory.

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Wald says any bounce in the Russell 2000 now is worth selling, and it is hovering near support at its 200-day moving average. "We are seeing some of these late-cycle conditions develop and at this point, I believe the strength is with big-cap stocks," he said.

Wald said while the Russell has been diverging for a month now, a multimonth divergence would be a negative signal for the bull market, which is in late stages.

"It's rare if you look back at all the cycles going back 80 years, only '94 to 2000 and '82 to '87 were longer and stronger than this one," Wald said. "Duration-wise we're getting there. The longest (bull market) cycle was 64 months, and we're about 61 months."

But that does not necessarily mean the bull market is close to its end. In those prior periods, the Fed was removing stimulus and raising rates. The Fed has signaled it does not expect to raise rates until the second half of next year, though it is removing stimulus by paring back its bond-buying program.

"A lot of the cyclical sectors still look pretty strong. I would still play technology and industrials ... material and energy right behind it," Wald said. He expects consumer discretionary to continue to weaken.

Those are the sectors that are showing the most emerging strength against the S&P 500. In the past five days, energy stocks have been up 5 percent and industrials up 3.8 percent, followed by a 3 percent gain in both materials and health care.

As for financials, Wald said they would become more attractive with rising rates. "I like the story of rising rates. I think the market could still as a whole, do better. It's (10-year yield) still holding 2.5 percent, and it's just not backing up. The banks will do better if rates move higher," he said. The market would have a problem, however, if rates got too high, too quickly.

Wald said a stock market correction does not necessarily mean a big drop, and it could come in the form of a sideways correction. "We had these very muted bull market corrections in 2012 and 2013, and I think the reason for that was that bonds posed less risk for stocks. We had ultralow rates," he said, noting that could change. Rates would become troublesome for stocks when the 10 year reaches 3.5 percent, he added.

Adam Parker, chief U.S. equity strategist at Morgan Stanley, expects growth to lag value, possibly into next year. The fastest revenue growers are in Internet, biotech and airlines but many of those are at highs of valuation.

Parker, appearing on "Fast Money," said the signal from the Fed is not clear on when it will begin hiking rates, so he says the message from the market is to be in value. "The last few times, we've had a rally of value stocks this great over growth stocks, it tended to last on average about 10 months. On average, value outperformed growth by 6 to 7 percent," he said.

"It could last another eight or nine months more," Parker said, adding the message from the market is sell some hyper-growth exposure and add a little more value. His target for the year is 2,014 on the S&P 500.

Besides earnings, there is existing home sales Tuesday at 10 a.m. ET and FHFA home price data at 9 a.m. The Treasury auctions $32 billion in 2-year notes at 1 p.m..

—By CNBC's Patti Domm.