How to Play the Market’s Big Money Rotation
Investors are buying up legacy companies as quickly as they are dumping innovative digital businesses.
Everything is upside down … and it may stay that way for a while.
Shares of Hewlett Packard (NYSE: HPQ) jumped last week to a new high as DocuSign (Nasdaq: DOCU) stock plummeted.
Luddite investors are choosing printers and messy ink over the digital equivalent.
- There’s an overall trend here: The stock market is in the midst of a rotation.
It’s the beginning of the year, and the big money is pouring into the market.
Large institutional accounts skew heavily toward conservative, value investing strategies. This makes sense. Their investors — mostly pension funds — are more afraid of losing capital than posting big returns.
Holding Hewlett Packard in the portfolio is an easier sell to clients than DocuSign.
While that may seem strange because of DocuSign’s growth potential, it’s not that difficult to understand.
- Hewlett is a fundamentally cheap household name, whereas DocuSign is a cloud-based software platform for signing documents virtually … and it’s also relatively expensive and unfamiliar.
The other major variable is rising interest rates. Institutional Investor notes that value investors blame the Federal Reserve and a decade of low interest rates for their poor performance relative to their growth contemporaries.
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Value managers also claim that higher interest rates will negatively impact growth stock valuations. In the short term, this narrative can drive stock prices.
The yield of the 10-year Treasury bond rose last week to 1.76%, up from only 1.3% a month ago. Using the S&P 500 Value ETF (NYSE: IVX) and S&P 500 Growth ETF (NYSE: IGX) as benchmarks, during the past 30 days, value is up 4%, while growth is down 3.8%.
However, over time frames longer than a quarter or two, investors would have been better off choosing growth over value strategies regardless of whether rates were rising or falling.
Growth beat value by 28% from the pandemic lows in 2020 through last week, even as rates have risen sharply.
The margin widens to 105% over the past five years, and 258% over 20 years.
- In spite of how often it’s repeated in the financial press, the inflection point for growth vs. value strategies is not the trend for interest rates: Value strategies perform best at the beginning of each calendar year when institutional money inflows are the highest.
It makes perfect sense that Hewlett shares have been stronger. At $38.65, the stock trades at only 8.3 times forward earnings.
The dividend is 2.0%, and the gross operating margin is 21.1%, an extremely respectable rate many value investors have noticed.
However, it’s wrong to dismiss DocuSign outright.
Although the company is not profitable yet, sales grew to $545 million in the third quarter … an increase of 42% year over year.
Gross operating margins moved up to 79%, 500 basis points higher than a year ago.
- While DocuSign is still going to be a great buy in the future, there are better opportunities knocking at the door right now because of the new market trend.
And one of them is with Oracle (NYSE: ORCL).
The company is the global leader in database management systems. Its software helps large clients wring out useful information from large pools of information.
Given the scale of that business, Oracle has become a cash cow, allowing executives to return capital to shareholders at breakneck pace.
The company bought back 329 million shares in the past year alone, spending $21 billion. Dividends accounted for another $3 billion.
- The database giant is growing briskly in the cloud, too. Unlike competitors, its portfolio includes applications, platform and infrastructure services.
The company reported in December that second-quarter sales reached $10.4 billion, up 6% year over year. Total cloud revenue surged 22% to $2.7 billion.
Shares have come under pressure since Dec. 16 when executives announced the $28.3 billion purchase of Cerner (Nasdaq: CERN), a digital medical records business.
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In the current climate — where investors are swapping growth for value stocks — the weakness is an opportunity value investors are certain to notice.
For many decades, Oracle has been the quintessential growth stock, fundamentally too expensive to value investors.
At $87.51, shares now trade at only 16.6 times forward earnings and company leaders claim that the Cerner acquisition will be accretive. The dividend yield is 1.3% and gross operating margins are remarkable at 80%.
Longer-term investors should consider buying Oracle shares into the current pullback.
Jon D. Markman
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