Large-cap stocks are relatively attractive, but not across all sectors, argues Lucy MacDonald, London-based chief investment officer of global equities at RCM. She says financials remain the sector to avoid among blue-chips, while other large-cap sectors are capable of sustainable earnings growth.
Her recent market predictions for AsianInvestor magazine have been prescient. Interviewed for a survey on global equities for the March edition, she noted the lag in performance of larger growth-orientated high-quality stocks in 2009, a year that has seen considerable outperformance of small, value, low-quality stocks. As she predicted, growth and quality stocks have, since then, performed better.
"With this catch-up, there is now not a huge spread between the indices of the high- and low-quality stocks," she says. Larger stocks look more interesting to MacDonald in general, but the point is complicated by sectoral issues. She remains cautious on financials, a group clearly over-represented among large-cap firms.
MacDonald's March preference for quality remains. "The risk on the debt side means firms that can fund their own growth - those which don't have to rely on external financing - will do better," she notes.
Meanwhile, the momentum around growth stocks is slowing. A year ago, earnings forecasts were downgraded too far; there followed a huge upgrade momentum, which she expects will reverse. "Next we'll be getting some disappointment around earnings, again favouring those firms that can generate organic growth."
Tech and certain healthcare firms remain popular with MacDonald, along with some consumer and industrial names. But she is underweight financials, noting that banks have already recovered a long way despite the relative paucity of data about balance sheets, especially in Europe, and considerable uncertainties around regulation and tax.
"The biggest risk in the European banking sector is that the level of debt in the system still hasn't been flushed out," she says. "The US banks were forced to come clean and declare exactly what they were holding; the attitude in Europe has been more gentle, and we still need more clarity." She notes that a similar lack of disclosure in Japan several decades ago created a slew of never-dying zombie institutions.
On the regulatory front, MacDonald's caution is supported by government activity on both sides of the Atlantic. In the US, Congress now looks likely to force the banks there to spin off their lucrative swaps desks from the rest of the business, insisting they be independently capitalised.
The move looks more likely since influential White House adviser Paul Volcker softened his opposition to the plan. It follows news on June 16 that last year's UK government bank bonus tax cost US banks $2 billion. The sum, which amounted to the lion's share of the total $2.5 billion raised, is predicted to shave around 10% off second-quarter profits at Bank of America, Citi and JP Morgan.
The UK banking tax may not be the last case of smash-and-grab on the banks, says MacDonald. Governments are looking for money, she notes, and the banks currently have plenty. The proposed 40% super tax on mining companies by the Australian government shows the strategy in action. Regulators in Germany and the US look jumpy, and the resilience of bank profits conspires with the public's disenchantment and determination to keep banks in the firing line.
In the UK, the prospect of a forced splitting-up of the banks grows more likely. Also on June 16, Chancellor George Osborne launched a comprehensive banking review that will investigate the case for dividing the retail from the investment banking arms of the major banks. Barclays looks particularly vulnerable, says MacDonald.
Still, there may be a little upside in the sector with regard to government-owned banks, she says. The 2008 deal with HBOS that almost put an end to Lloyds TSB has at least succeeded in securing a leading market share for the UK bank. If the bad loans of HBOS are sorted, she notes, "and the bank starts paying a dividend, the firm may work as a financial utility".
Moreover, analysts report that European lending is set to become more lucrative, where mortgages amount to around half of total loans. If the base rate stays below 1.5%, note Credit Suisse analysts this month, mortgage income for these lenders could rise by more than 70% to £16.5 billion.