After watching smaller stocks dominate the early stages of the current market rally, investors are finally turning their attention to shares of big, blue-chip growth companies.
At first blush, this transition isn’t at all surprising. Despite signs of an improving economy, uncertainties abound in the credit and financial markets. And it’s only natural during uncertain times to gravitate toward investments perceived as dependable, though boring.
Furthermore, because large growth stocks haven’t soared as much as others since the market began to rebound in early March, their prices are still fairly attractive. For instance, growth stocks in the Standard & Poor’s 500-stock index of blue-chip companies are trading at a price-to-earnings ratio of 15.1. That’s a 42 percent discount to the P/E for small stocks in the S.& P. 600, even though the two groups have historically enjoyed roughly similar valuations.
But one thing is remarkable about the turn in sentiment: It’s been nearly a decade since fund managers and individual investors considered blue-chip growth stocks to be among the most desirable areas of the market.
“It just goes to show that stocks of a particular style or sector can be out of favor for years,” said Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago.
James B. Stack, editor of the InvesTech Market Analyst newsletter, said that “what you find is that investor psychology tends to move in waves.”
Typically, it works like this: First, investors gravitate toward a certain type of stock. Then they overstay their welcome in it, riding it down in a market correction. Then, soon after the downturn, they try to go back into those stocks in hopes of enjoying a quick rebound, only to be burned again.
Large-cap growth stocks, which include technology and health care shares, are a perfect example. They were clearly the favored asset class in the late 1990s, during the Internet boom that propelled shares of tech giants like Microsoft, Intel and Cisco Systems to stellar gains.
After large growth stocks lost nearly 56 percent of their value from March 2000 to October 2002, they enjoyed a bounce in 2003, at the start of the bull market.
But that rebound proved short-lived, and these share prices generally declined. “People’s perspectives about these stocks have been heavily influenced by their experiences in the late ’90s and the early 2000s,” said Erik Ristuben, chief investment officer for North America at Russell Investments.
Mr. Stack fears that investors may be showing a similar pattern with the favored asset classes of the bull market of 2003 to 2007.
“You’re seeing the same thing today in commodity and energy stocks,” he said. Like large growth stocks in the late ’90s, commodity and energy stocks soared in 2004 and 2005, but were upended by the bear market that started in October 2007.
But since the market started rebounding in early March, the S.& P. GSCI commodity index has soared nearly 26 percent while energy stocks have risen nearly 30 percent.
Both of these groups are surging on hopes that the improving global economy will significantly bolster demand for energy and raw materials, market strategists note. But history says that “you have to question whether these asset classes are going to be among the more profitable ones over next 12 to 24 months,” Mr. Stack said.
Of course, there are important differences between commodities and large blue-chip growth shares.
For starters, large domestic growth stocks “are not a group that by nature spend that much time leading the market — for the simple reason that they are big, stable companies,” said Ben Inker, director of asset allocation at GMO, the asset management firm based in Boston.
“When people look for stories to be really excited about, they don’t spend much time talking up household names like Coca-Cola, Johnson & Johnson or Microsoft,” he said.
Still, the long fade of blue-chip stocks is a reminder that it can take a while for all the excesses to be wrung out of a market bubble.
For example, the P/E ratio of blue-chip stocks — based on 10-year average earnings — soared above 44 in 1999. That was much higher than the historical average of 16.
But even after the bear market of 2000 to 2002, the P/E ratio for the blue chips was still higher than 23.
It wasn’t until more than year into a second devastating bear market — in November 2008 — that valuations for this class finally fell back to their historical average.
It’s a sobering lesson for investors expecting quick rebounds among yesterday’s winners — including commodities, emerging-market shares or even real estate. History suggests that a long and painful ride may be ahead of them.
Paul J. Lim is a senior editor at Money magazine. E-mail: firstname.lastname@example.org.