Hippo grows horns as attention turns to growth stocks

Global equity markets have the potential to provide investors with another year of good returns, with growth stocks leading the way, according to Jupiter fund managers.

While concern over the extent of the economic slowdown in the US will continue to cause some volatility in markets as we move into 2007, Jupiter’s managers believe the economy is likely to stage a relatively controlled slowdown. Against this backdrop, the outlook for the global corporate sector is broadly positive. Balance sheets are likely to remain in good shape and, while there will undoubtedly be some profit warnings in selected areas, aggregate profit growth should remain healthy. Companies are, as a result, likely to continue returning value to shareholders through higher dividends.

This, combined with attractive valuations and continued M& A activity, creates an encouraging environment in which equities can make good headway. However, the type of shares that will lead this next phase of the bull market is likely to shift, with growth stocks capable of producing superior returns.

The Hippo Market

As Jupiter’s Joint Chief Executive and Chief Investment Officer, Edward Bonham Carter, predicted at the end of last year, the Hippo - that unpredictable beast that wallows around most of the time with occasional bouts of activity that can prove hazardous for onlookers - grew horns in 2006.

Since the end of the bear market, global markets have made excellent progress. The FTSE 100, for example, has risen about 85% since its low of 3,287 on 12th March 2003. Yet many markets are still below their previous highs – in the case of the FTSE 100, some 12% below, and, with global growth slowing, returns are likely to be harder to achieve.

However, the three-year recovery in markets is unlikely to end here. Bonham Carter explained: “While the US economy is going through a mid-cycle slowdown, I doubt we are heading for a recession in the short term. We are likely to see only limited rises in inflation while wage growth remains under control and the West continues to benefit from cheap imports from China and other emerging markets. In addition, while interest rates have risen, they are still low on a historical basis.

“Against this backdrop, equities have the potential to make further gains in 2007, particularly as the drivers of M& A activity - the low cost of debt, strong corporate cashflow and attractive valuations - remain in place. So, the Hippo will continue to display its horns in 2007, although I would not expect the FTSE 100 to surpass its previous high for some time yet.”

Global Investment Trends

John Chatfeild-Roberts, head of Jupiter’s Independent Funds Team agrees there are a number of reasons to be positive on the outlook for equities: inflation is currently under control, US leading indicators look robust, China continues to grow at a healthy rate and European earnings growth is likely to be in the double digits. In addition, world liquidity is plentiful, particularly in the Oil states and; true growth companies look undervalued.

Chatfeild-Roberts said: “Markets have to climb a wall of worry and while there are certainly some concerns, particularly regarding the health of the US consumer, I believe these are somewhat overplayed.

“We are of the view that the ingredients are more or less in place for the current rally to continue. However, we do believe that we are heading for a significant shift in sector leadership, with growth stocks poised to pick up where cyclicals have left off – the Jupiter Merlin portfolios have been adjusted to reflect this.

“We have reduced our exposure to funds that tend to do well when value stocks are in favour, refocusing on funds that have a growth bias. Our exposure to the US market has also been increased, reflecting the fact we have become more optimistic with regard to the US market. In addition, we remain broadly positive on Europe and the UK and have also taken positions in Latin America and China where we can find reasonable valuations and strong growth prospects.”

Value and growth converge

After several years where value stocks have outperformed growth stocks in the UK, there has been some convergence in returns in the past two years – a trend that is likely to continue, according to Anthony Nutt, manager of the Jupiter Income and Jupiter High Income funds.

He said: “Six years ago you would pay one price for, say a utility stock and another for a telecom stock but the convergence between value and growth has meant that you are now really paying the same price for everything. This is making it much more difficult for value managers such as myself to find investment opportunities.

“In addition, while M& A is giving a boost to returns in the short run, it does reduce the potential investable universe in the UK. This does not mean I am bearish on the outlook for the UK market, particularly while dividend growth remains so strong. But I do believe the only way of ensuring decent returns in this kind of market is to focus on companies that are capable of producing strong dividend growth. In a world where global growth is slowing, rising dividends become an increasingly important component of total returns.”

UK equities still good value

Ian McVeigh, manager of the Jupiter UK Growth fund, believes the UK market remains good value. He points out that while the FTSE 100 remains 12% or so below its 1999 peak, profits have grown strongly – by around 50%.

He said: “Earnings per share growth in the UK has gone from 7.3% in 2000 to 14.5% in 2003, 16.5% in 2004 and 10% in 2005, yet the market is on a forward P/E of 12 to 13 times to the end of 2007. This compares with a forward P/E of 23 times at the end of 1999. These numbers tell me that UK stocks have de-rated and that, combined with continued M& A activity, means the prospects for strong share price performance going forward remains excellent.

“The Jupiter UK Growth fund is very flexible in terms of style and size bias, so we aim to choose from across the range of growth, value and recovery stocks in the UK market. In current conditions, I am focused on growth and value-style stocks, rather than recovery plays, with a bias towards large caps. About two thirds of the portfolio is in blue chips, while a quarter is in mid-size companies and the remainder is in small caps.”