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How growth strategies can be a barometer of the market mood

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Share prices have been in recovery mode over the past four months. After a sharp slide on the UK market late last year, the bulls appear to be back in charge in 2019. When it comes to investment styles, some of the big early winners from this kind of change in sentiment are the growth strategies – and we’re starting to see the signs of that.

The bulls fend off the bears… for now

Last autumn’s market dip had many of us wondering whether time was officially up for the long running momentum streak. But while the downswing was dramatic, the mood has turned much more upbeat in 2019.

The large-cap FTSE 100 index, for instance, is up by 10 percent since January. The FTSE 250 and the growth-focused AIM All-Share are both up by 13 percent. Setting the tone for all this – on the other side of the Atlantic – the US Samp;P 500 is once again troubling the record books as it stretches to new all-time highs.

Among the top UK performers over the past six months, the biggest gains across the FTSE 350 have been in stocks like Ocado, Micro Focus International and Greggs. On main AIM board, the big winners have been the likes of ReNeuron and Earthport (on a takeover approach from Visa). And on the AIM 100, the leaders have been AB Dynamics and the relatively newly-listed Codemasters.

Swings in sentiment

Late last year it was clear that the negative market momentum was causing problems for some of the most popular growth stock strategies. When confidence wanes, growth stocks are often the first to sell-off as investors opt for safer territory. So in the final three months of the year, growth and momentum strategies were among the biggest losers.

An additional challenge for growth strategies in bearish conditions is that they often struggle to find buying options. Typically, most of these approaches will look for some variation of earnings growth, quality and price strength in the shares they target. So in falling markets, negative momentum can result in very few shares passing their rules.

So it was pretty bleak for growth investors for a time in early 2019. Yet one of the boons of a pull back in prices is that strategies which buy growth at a reasonable price (GARP) can be very well positioned when markets bounce back. With momentum building, GARP has been back in business recently, and that’s exactly what we’ve seen in approaches like the Jim Slater inspired Zulu Principle strategy.

How Zulu moves with the market

This strategy is well loved in the growth investor community. Slater’s GARP model, which used his own version of the Price Earnings Growth measure – or PEG – is designed to find fast moving growth stocks.

Slater saw the PEG as a crucial measure of whether a stock offered an attractive trade off between price and growth. It is calculated by dividing forecast price-to-earnings ratio (PE) by the expected rate of earnings-per-share growth (G). As he saw it, stocks with a PEG of less than 1 had higher growth rates than their PE ratios and were thus ‘cheap for their growth’. For instance, a stock on a forecast PE of 20 but expected to grow at 25% would have a PEG of 0.8.

The really eye catching aspect of this screen is that it’s not only the best performing strategy of all the Guru Screens that we track over a five year period – but it’s also right up there on a three, two and one year timescale. We’ve recorded a five year gain of 116 percent, albeit in our lab conditions where the portfolio is refreshed every three months and trading fees are excluded. But in many ways it’s the consistency that really makes this strategy impressive.

Yet one of the criticisms of the Slater strategy – and it’s something we see in other GARP strategies too – is that it shuts up shop in downturns. The stocks it holds can get hit hard and it struggles to find buying candidates. But as this chart shows, it responds fairly swiftly when confidence picks up again. That makes it quite an interesting barometer of the general market mood.

Earlier this year the strategy was on the ropes, with very few companies passing the rules. But we’re starting to see the numbers swell. Here are some of the stocks currently passing those Zulu Principle rules:

Name

Mkt Cap £m

P/E Ratio 1y

PEG Slater

EPS Gwth (pc) Rolling 1y

ROCE (pc)

Relative Strength 1y

Pelatro

27.5

7.1

0.18

40.0

15.1

+11.9

Mamp;C Saatchi

333.4

16.5

0.24

68.3

12.2

+0.02

SimplyBiz

199.4

15.7

0.36

44.0

24.1

+32.1

Next Fifteen Comms

471.4

15.1

0.37

41.1

12.5

+21.7

Midwich

490.2

19.0

0.46

41.6

32.0

+7.35

Belvoir Lettings

39.7

8.7

0.48

18.0

15.7

+8.0

Macfarlane

156.9

12.3

0.49

25.0

15.5

+18.1

Scientific Digital Imaging

51.5

16.1

0.50

32.0

13.2

+43.2

Johnson Service

563.4

15.2

0.69

22.0

12.3

+10.9

Impax Asset Management

304.5

17.7

0.75

23.8

24.3

+51.2

A few of these names have been regulars in the portfolio over the past two years, such as Pelatro, Macfarlane, Johnson Service and Impax Asset Management. But we haven’t seen these sorts of qualifying numbers for over 12 months. Most of the improvements seems to be because the 1-year relative price strength of these firms has clawed its way back into positive territory, which means they’re passing all of the Slater rules. As a result we see new names like Mamp;C Saatchi, SimplyBiz, Next Fifteen, Midwich and Belvoir Lettings.

So overall, while the market hasn’t quite recovered the ground it lost last year, it’s a relief that prices are once again trending upwards. For growth investors – some of which may have been shaken out of the market last year – positive momentum could mark a chance to buy back in at cheaper prices. These kinds of shares are some of the most sensitive to changing market sentiment – and right now it looks like they’re starting to bounce back.

Stockopedia



Source: https://www.stockopedia.com/content/how-growth-strategies-can-be-a-barometer-of-the-market-mood-473166/


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