I am still cautious on mega caps, the largest of the large caps. We are avoiding any new positions of the extreme valued companies and am focusing on growth with a reasonable price. We may still have another correction in the equity markets ahead but don’t see it necessary to go all into defensive or value. We are sticking with a central core basis.

Currently growth and value are similarly overvalued. The S&P 500 Value index is 6% above its 5 year average forward P/E compared to the 5% premium for the S&P 500 Growth. It is notable the S&P 500 Growth valuation came down sharply in January’s correction while Value has been slowly contracting since the spring of 2020. (see chart) But even in a rising interest rate environment the S&P 500 Value forward P/E continues to contract below its 2021 peaks.

The whipsaws between Growth and Value leadership over the past 2 years have been dramatic and timing has been challenging. I have used style ETF’s in the past 2 years and generally advocate using broad based style ETF’s to shift style basis when either style looks strongly but do not have any of those currently.

We have slightly reduced our allocation to US large caps in favor of Midcaps as they offer a more attractive growth at a reasonable price. This could be early call as investors shift more towards fixed income but given we’ve seen already seen widespread risk-off trades in Q1 we feel the risk reward is too compelling to miss. We feel that as inflation concerns diminish midcaps can easily outperform large.

The reason for our conviction lies largely based on relative valuations and expected growth. The valuation spread between large and midcaps has become increasingly wider over the past 2 years. While some spread is expected during periods of higher interest rates, the 32% premium on large caps is extreme by historical standards. The S&P Midcap 400 normally trades at HIGHER valuations than large caps, because of their higher growth, but is now trading at a 32% DISCOUNT. We do not expect this inversion of premiums to persist long term and expect a reversion where midcaps could significantly outperform.

Another stellar earnings quarter but perhaps the beat rate and surprises might be heading towards pre-pandemic norms. The % of companies beating estimates looks to be declining for a second quarter form the record 86% for the Q2 last year. Prior to the pandemic the 5-year average beat rate was 72%. Analysts might have an easier time estimating future profits as we reach an endemic economic stage and companies may not be able to beat forecasts so easily.

While a portion of the upward revision is attributable to the volatile Energy sector (revised up 11% to 39% 2022 EPS growth), Information Technology (i.e. traditional tech) and Real Estate have also seen big positive revisions. There is the notable downward revision in the Communication Services sector, from Meta’s disappointing Q4 report . Social media giants like Meta and Twitter received big declines in their 2022 forecasts pulling the Communications Services sector down which is dominate by “new tech” social media companies….(read more)

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