Equity markets are going through a contradictory phase, with de-coupling trends causing problems for stock pickers and growth stocks looking set to continue outperforming value, according to Fidelity’s Jeremy Podger. 
Podger (pictured), manager of the £2.6bn Fidelity Global Special Situations fund, argued that investors need to apply more vigilance and selectivity over the summer months in reaction in light of several apparent contradictions playing out in the markets
“We have also seen a number of long-held correlations break down over recent times. This has made for a tricky environment for stock pickers, who could have easily owned the wrong stocks even if they identified the correct top-down trends,” he said.
The first is that as the gap continues to grow between the performance of value and growth stocks, the FE Alpha Manager sees no sign of this trend subsiding anytime soon.
Over the years value stocks have had periods of significant outperformance against growth, leading investors to ask when the current trend will eventually reverse itself. But Podger sees no end to the reign of growth’s outperformance in the near future.
“Whilst growth valuations may look extended versus the last five years, we remain far from the valuation excesses of previous bubbles,” he said.
Performance of global growth vs global value stocks over 10yrs
Source: FE Analytics
“Whilst the underlying drivers might be different this time, this serves to illustrates the point that once a trend takes hold, the market can run it for quite some time before it breaks. If this is the case again, then growth could still have room to run further.”
The continuing divide between value and growth stocks is currently at a record high, with the gap between them now at more than 100 percentage points when measured over a 10-year period. Over the past decade large cap growth stocks have consistently outperformed value, enabled by factors such as loosening monetary policy and a bias towards passive investment – particularly in the US.
The second theme highlighted by the Fidelity Global Special Situations manager is the divergence between the performance of US quality stocks and US high yield spreads. quality stocks have tended to perform relatively well when spreads have widened in the past and suggested that investors are concerned by the economic outlook.
“But more recently we’ve seen quality outperform, despite tighter spreads suggesting a healthy economy. This divergence has only widened in 2019,” Podger added.
Source: Fidelity International, Bloomberg, 7 May 2019
“At an aggregate level we now see quality trading well above its long-term average relative valuation versus the broader market. It appears that investors are too scared to move into value, preferring instead to stick to quality for fear of an impending macro slow down.
“This makes stock picking extremely difficult – had you correctly predicted high yield spreads would tighten in 2019, you would have likely positioned in value stocks and subsequently underperformed.”
The manager also noted a de-coupling of the correlation between the US energy sector and the price of oil.
Source: Source: Fidelity International, Bloomberg, 7 May 2019
The two started to diverge in 2016 with energy stocks underperforming even as oil rise, despite a long-term correlation between the US energy sector and oil prices over the past 20 years.
“This decoupling has been particularly pronounced year-to-date, with global energy stocks underperforming the index despite a 35 per cent rise in the oil price,” he said.
“Whilst we remain constructive on the outlook for the commodity, one cannot help but wonder if there are more structural drivers at play-are investors giving up on fossil fuels? One could certainly draw analogies with the de-rating and capitulation on the tobacco sector in the 90s.”
Podger also pointed out that there is a disconnect between the path that the stock and bond markets expect monetary policy to take in the months ahead.
“US bond markets are now pricing in two Federal Reserve rate cuts over the next two years -historically a bearish indicator, yet at the same time US high-yield spreads have tightened significantly year-to-date,” he noted.
“In equities, consensus continues to forecast double-digit earnings per share (EPS) growth for the S&P 500 in 2020 - it seems unlikely to us that all three measures can be correct.”
Looking at how he plans to align Fidelity Global Special Situations to cope with these global issues, Podger is maintaining what he described as his “cautiously optimistic” stance.
He said: “We remain cautious about the level of recovery baked into expectations for the second half of 2019.”
Podger sees potential for returns in equities, particularly in Japan. But he recommends investors focus on equity stock fundamentals, especially with global political uncertainty caused by ongoing trade wars and political riots and protests.
“We continue to look for stocks offering compelling value,” Podger explained. “Japan stands out on valuation grounds, trading all-time lows on a relative price to book basis at a time corporate reform is calling for greater scrutiny on capital allocation and ultimately driving improved returns.
“We are also searching for stocks where we have high conviction in positive earnings trends, a group that is becoming harder to find and trading at ever greater premia to the market-we will continue to apply strict valuation criteria and remain highly selective in this area.”
Fidelity Global Special Situations has made a 228 per cent total return over the past 10 years, outpacing the 216.74 per cent made by the MSCI AC World index and the 177.37 per cent gain by its average IA Global peer.
The fund, which has a value approach to investing, has an ongoing charges figure (OCF) of 0.92 per cent.