The Investment Column; Cyclicals and small caps swing back into favour

AS THE mid-point of the year draws near, it is clear that it has been a topsy-turvy six months for UK investors. While 1998 was the year of the growth stock with sectors like telecoms, pharmaceuticals and computer services all recording huge gains, their progress has been more pedestrian this year.

By contrast, cyclical stocks, the great unloved of 1998, have returned to favour. Some of the worst performers of last year such as mining, chemicals and construction have recorded some of the healthiest gains.

The mining sector, for example, underperformed the rest of the market by 22 per cent last year but has outperformed by 39 per cent in the first six months, helped by swings in commodity prices and a return of investor support. But can these trends continue?

A recent piece of research by the equities strategy team at Salomon Smith Barney compares the fortunes of what it describes as "momentum" and "contrarian" investors. At the start of every year a contrarian investor buys the worst performing 10 stocks of the previous year and sells the best 10. The momentum investor does the opposite. The theory is that the stocks they sell have as big an impact on their portfolio as those they buy.

Salomon's figures show that contrarian investment returns have only beaten the momentum brigade in five of the past 14 years. Last year would have been the worst performance for contrarian investors since 1984.

By contrast, the momentum investors would have enjoyed a storming 1998 with a combined outperformance of around 50 per cent buoyed by huge rises in stocks such as Orange, BT and Vodafone.

But there has been a shift this year with the worst performers of 1998 such as British Steel and BTR (now Invensys) recording big gains. The reason, Salomon says, is because of the change in the economic outlook, with fears of a hard landing last autumn proving unfounded. A rebound in expectations of an economic improvement in the US has also been a major factor.

The shift has had a dramatic effect on sector rotation and performance. Of the 10 best performing sectors last year only telecoms and electronics have continued to outperform over the last six months and even those at a lower rate.

But should we all be piling into Pilkington and ICI? Not necessarily. Salomon says that while there has been a shift in sentiment there is little scope for the earnings upgrades that will drive the share prices higher still. A further leg of outperformance therefore looks limited.

It is a view supported by Bob Semple, chief equity strategist at BT Alex.Brown. His view is that the bulk of the re-rating for cyclical-industrials, such as oils, took place in the first few months of the year and that further progress is limited until later in the year. Consumer cyclicals such as general retailers have not yet enjoyed such a recovery and require further evidence of a pick-up in Europe and Asia.

The equity team at Merrill Lynch is more bullish. It says the economic backdrop makes cyclicals and smaller caps more attractive than growth stocks and larger companies. It is most positive on banks, construction, engineers, brewers and gas while recommending underweight positions in pharmaceuticals, telecoms and media.


Start your day with The Independent, sign up for daily news emails
ebooksAn unforgettable anthology of contemporary reportage
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Digital Optimisation Executive - Marketing

£30000 - £35000 per annum: Recruitment Genius: The UK's fastest growing, multi...

Recruitment Genius: Financial Reporting Manager

£70000 - £90000 per annum: Recruitment Genius: A Financial Reporting Manager i...

Recruitment Genius: Payments Operations Assistant

£23000 - £25000 per annum: Recruitment Genius: They win lots of awards for the...

Recruitment Genius: Telephone Debt Negotiator

£13500 - £20000 per annum: Recruitment Genius: This nationwide enforcement com...

Day In a Page

Sepp Blatter resignation: The beginning of Fifa's long road to reform?

Does Blatter's departure mean Fifa will automatically clean up its act?

Don't bet on it, says Tom Peck
Charles Kennedy: The baby of the House who grew into a Lib Dem giant

The baby of the House who grew into a Lib Dem giant

Charles Kennedy was consistently a man of the centre-left, dedicated to social justice, but was also a champion of liberty and an opponent of the nanny-state, says Baroness Williams
Syria civil war: The harrowing testament of a five-year-old victim of this endless conflict

The harrowing testament of a five-year-old victim of Syria's endless civil war

Sahar Qanbar lost her mother and brother as civilians and government soldiers fought side by side after being surrounded by brutal Islamist fighters. Robert Fisk visited her
The future of songwriting: How streaming is changing everything we know about making music

The future of songwriting

How streaming is changing everything we know about making music
William Shemin and Henry Johnson: Jewish and black soldiers receive World War I Medal of Honor amid claims of discrimination

Recognition at long last

Jewish and black soldiers who fought in WWI finally receive medals after claims of discrimination
Beating obesity: The new pacemaker which helps over-eaters

Beating obesity

The new pacemaker which helps over-eaters
9 best women's festival waterproofs

Ready for rain: 9 best women's festival waterproofs

These are the macs to keep your denim dry and your hair frizz-free(ish)
Cycling World Hour Record: Nervous Sir Bradley Wiggins ready for pain as he prepares to go distance

Wiggins worried

Nervous Sir Bradley ready for pain as he prepares to attempt cycling's World Hour Record
Liverpool close in on Milner signing

Liverpool close in on Milner signing

Reds baulk at Christian Benteke £32.5m release clause
On your feet! Spending at least two hours a day standing reduces the risk of heart attacks, cancer and diabetes, according to new research

On your feet!

Spending half the day standing 'reduces risk of heart attacks and cancer'
With scores of surgeries closing, what hope is there for the David Cameron's promise of 5,000 more GPs and a 24/7 NHS?

The big NHS question

Why are there so few new GPs when so many want to study medicine?
Big knickers are back: Thongs ain't what they used to be

Thongs ain't what they used to be

Big knickers are back
Thurston Moore interview

Thurston Moore interview

On living in London, Sonic Youth and musical memoirs
In full bloom

In full bloom

Floral print womenswear
From leading man to Elephant Man, Bradley Cooper is terrific

From leading man to Elephant Man

Bradley Cooper is terrific