Ready for the great rotation of 2014?

As the economy continues to heat up, look for investors to shift their focus in the new year.

By StreetAuthority Dec 31, 2013 4:07PM
Caterpillar construction equipment (© Kristoffer Tripplaar/Alamy)By David Sterman                                                                 
Investors in small-cap stocks have rarely had it this good.

The Russell 2000, which stood below 400 in early 2009, is quickly approaching the 1,200 mark. It's as though two decades worth of gains have been packed into just five years.

The small-cap surge shouldn't have come as a total surprise. As I noted on our sister site InvestingAnswers.com a few years ago, small-cap stocks often outperform large-cap stocks when the overall economy is coming out of a recession.

Yet as we turn the page and head into 2014, it's crucial that you understand how a changing economy will influence this trend. For a host of factors, small caps are likely poised to underperform their large-cap peers.

In August, I explained why investors should shift assets into larger companies, and since then, the reasons for owning big-cap companies have only strengthened.

First, the market has moved even higher since last August, with the Russell 2000 up another 9% and the S&P 500 Index rising another 8%. If investors are looking to lock in profits in 2014, then larger companies, especially those with robust buyback and dividend policies, are likely to hold their own better than small caps.

Much more importantly, it's the recent economic releases that point to a better backdrop for larger-cap companies.

          Post-Recession Performance (prior to 2009)


As I noted back in 2010, small caps do well as the U.S. economy edges out of recession because these smaller companies have more direct exposure to the U.S. economy. Indeed most of these firms haven't felt the pain of a still-weak European economy. Bigger firms, in contrast, have been weighed down by slower growth at their foreign sales units. In places like Europe, that's becoming less of a drag.

Also, large firms are much more attuned to higher capital spending. According to Goldman Sachs, fixed investments by businesses, also known as capital spending, likely grew just 2.5% in 2013. Yet Goldman thinks that will figure will surge to 6.8% in both 2014 and 2015, and 5.5% in 2016. Capital goods manufacturers such as GE (GE), Honeywell (HON), Caterpillar (CAT) and United Technologies (UTX) stand to be clear beneficiaries.

Of course, smaller companies would stand to benefit as they are key suppliers to these big firms. It's why small-cap industrials are likely to be one of the few pockets of strength among all small caps in 2014.

Why does Goldman suspect that capital spending is about to pick up? Because the numbers are already improving. Orders for durable goods (aircraft, machinery, appliances, etc.) rose 3.5% in November, the largest increase in nearly a year.

The robust durable goods figure has led economists to suspect that fourth-quarter GDP growth may approach or even exceed 3%. Recall that third-quarter GDP growth figures were pumped up by inventory building, which typically creates a hangover in supply chains in the subsequent quarter. Back-to-back quarters of GDP growth in excess of 3% would be undeniably impressive. It's happened only once since the Great Recession ended (the fourth quarter of 2011 and the first quarter of 2012).

I still think that mega-cap exchange-traded funds (ETFs) are a great way to pay this theme. They include the iShares S&P 100 Index (OEF), the Vanguard Mega Cap Growth Index ETF (MGK), and the Vanguard Mega Cap Value Index ETF (MGV).

Now, here's where things get tricky. I am in the camp that expects stock market gains will be much more muted than in recent years. My colleague Michael J. Carr recently cited technical concerns for the market, and indeed a number of other technical indicators beyond what Michael cites also suggest overbought conditions.

But on a fundamental basis, I am growing a lot less cautious. The fact that the economy has managed to strengthen, even after the government shutdown and sequester issues, is undeniably impressive. Moreover, stocks are not expensive, especially in the context of very low interest rates.

Risks to consider: The economy is getting better, but the market's rally has anticipated much of that eventual improvement. So it's unwise to expect major gains in 2014. Also, many investors may look to lock in profits in early 2014, avoiding the tax man's 2013 bite.

Action to take: Over the course of this year, I have been eagerly awaiting a market pullback to reveal fresh buying opportunities. Yet that pullback never came. And so many stocks not trade for twice or even three times as much as they did a few years ago. As a result, few bargains exist. But a wide range of industrial stocks appear reasonably valued in the context of 2015 and 2016 results.

The firming economy increases the likelihood that these companies will generate a large cyclical upturn in profits.

My preferred strategy: Exercise patience as we head into the fourth-quarter earnings season, and keep an eye out for companies that issue tepid near-term guidance but are still deeply leveraged to a longer-term cyclical upturn. I'll be keeping an eye out for such bargains as they (hopefully) emerge in coming weeks.

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68Comments
Dec 31, 2013 7:39PM
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If I had followed most of the advice I have read over the last several years, I would be far poorer now. Maybe 2014 will be my downfall - especially depending on the 2014 elections and the "success" of Obamacare.
Jan 1, 2014 5:23PM
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The Great Rotation for 2014, Amateur Hour is likely over. Everybody and their Grandmother has touted themselves as stock geniuses since the Bull Run from the Great Recession began. Now these same folks are thinking a Correction will present the buying opportunity of a lifetime. Maybe and maybe not.

These same folks disregarded the collective actions of the Global FEDS and why this Bull Market has actually taken place. They will be just as naive when it all comes unglued. Just as the Crooks lied and stated nobody saw the Great Recession coming. They lied. Just as certain Apple Longs disregarded the price action in Apple. Sept2012 close of $700, those that bought on that day, still are underwater on their investment. In spite of the FACT of Record profits and Cash Hoards. Gravity's a Bitc..

I usually pull for the little guy, until he or she get's too cocky and that appears to be the case now. When folks began to disregard why and how things are done, it's only fitting they reap the negative downside if they ignore all warnings and never take profits. You can be certain of one thing, some folks will always hold to infinity and ride their winners into losers.

The top 1%, it matters very little financially to them if the Market rise or fall, that's why they are in the top 1%. A recession is a Garage Sale for them. They are like the House at the Casino, they always have the House Edge or Vig in their Favor. They have colluded with the Global FEDS to give the current illusion that everyone has the House Edge or Vig. When this House of Cards tumbles like all things built on Fiction, the party is literally over. The problem becomes what do the FEDS have left to put it all back together again.

Some posters will attempt to dismiss this by calling it negativity. Fact is it's exactly what has been going on here and Globally for decades. The problem that folks should be concerned with is, what price will we eventually pay for short term gains. A few years is just that, short term. WE are not Generational thinkers and therefore protecting our future. That will be our undoing not only for us, but for Generations that follow.





Jan 4, 2014 11:20AM
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I own my home in SW Florida paid for with cash. I own my vehicles with no payments. I own a small business too. But you still can't deny the fact that 93% of this nations assets are tied up in the top 20% largest incomes. 1% hold 40% alone. 

You can say that people are lazy and whining. But I know people that work 60 hours a week with two jobs and can't get a break for years and only make around $25k a year doing it. Wages are stagnant. They have figured out a way to make slaves out of the masses. Even with a degree you aren't guaranteed anything good in life. That's why I went with my own business. I don't have to count on the charity of trickle down economics. It's naive to think you can count on others to help you with money when they have it all tied up while they pay lower tax rates than people on welfare do. Average people pay 6.2% Social security tax. BUT if you make a million a year you get to pay around 1% because the max rate caps out at $14k a year or $113,700 income max. Imagine if they make $10 million a year. Then their rate is .01%. It's not right. Corporate welfare is 153 BILLION a year in subsidies while working poor or poor unemployed is 80 BILLION a year for food stamps. Get your facts right and look at who is really raping the system. Why should they get their profit margins in the taxes saved also? Because they have "DONATED" bribed politicians for these types of laws that the average American can't use.

You can't get stuck on your ego because you profess or one name or the other when voting. Just because you proclaim to be something doesn't mean it's right. Don't let your ego or bruising of it put blinders on your eyes when you use a magnifying glass for the others.  Use the REAL issues not made up false triumphant rhetoric. Use common sense. Common sense isn't all that common anymore.
Jan 4, 2014 1:58PM
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Listen to 10 "experts" and you'll get 20 answers, all of which will be WRONG.
Jan 4, 2014 1:07PM
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Like I would take financial advice from MSNBC...the obama administration propaganda wing.
Jan 4, 2014 5:41PM
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Are you one of the "little people" (a 1% and aristocrats term) who wants to get ahead?  If so, don't invest any money until you invest your time in toppling all the career politicians currently "representing"  (ha, ha) you.  They serve only themselves and the rich.  Kick out of office all the Dems and Repubs who have been there two or more terms and especially kick out all the super rich and all the aristocrat family members, and all the lawyers,  and vote in anyone who looks more like you, yes, the "little guy".   Joe the Plumber would be more effective representing you than any Kennedy, Kerry, Romney, Pelosi, Jackson, etc.   It is going to take an influx of "littlle people" to turn both the country and the economy around. 
Jan 4, 2014 3:27PM
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The economy is not really heating up and the markets will severely tank by election day.
Jan 2, 2014 8:23AM
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Davey321Zero must not have much to do, these days.  School off for winter break?

Dec 31, 2013 9:45PM
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The big focus in 2014 is Japan economy this is a big impact for the united states and Asian countries also china. I am seeing Japan and china economy will drop if a conflict breaks out.

Jan 1, 2014 3:47PM
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  Tog, Classic, Ntu, Enjoyed the comments over year especially on investments. Looking forward to 2014. Lots of negative market attitude on here. Generally lots of negative attitude means market continues up. Don't know that this site can be a gage in that regard though. Looks like VL is going to be as bitter this year as last. Don't know how old this guy is ,but people this bitter usually live short lives unless they thrive on being negative and bitter. Hope he mellows a little. Always fun to watch Classic usually overhaul those who choose to challenge her. Hope you all have a profitable 2014 and more importantly may you and yours stay healthy. Live long and happy. Good investing to all!
Jan 4, 2014 8:44AM
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Micro Stock - In marijuana (MJNA) (HEMP) (CBIS).  It's a damn shame but the other states and the FEDS are watching how Colorado does in the recreational use their of.  I know it won't be long lived but these stocks were up 60% in one day. I believe total legalization is coming, and for a 2 to 3 day run, when the FEDS say its legal nation wide, these stocks will go through the roof.  Call me crazy, but I will own 250,000 each without spending alot of money and I'm going to wait. Check out what happened Dec 30th, Jan 2nd. This was just on Colorado only.
Jan 13, 2014 5:59PM
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GOLDGOLDGOLDGOLDGOLDGOLDGOLDGOLDGOLDGOLD
Jan 1, 2014 7:48AM
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The ILO estimates a net loss of around 32 million jobs worldwide since before the world fell into the Great Recession. Note the Labor Participation rate here in America.

A Job Seeker in Europe, "You don’t even dare speak about pay anymore,” Lara says. “You’re so afraid they’ll just slam the door."

So in spite of the Record Profits and Cash Hoards for Corporations, they refuse to hire properly and or pay a living WAGE. Yet the Stock Markets have been on a tear. Most folks have identified the reason, massive Stock buybacks thanks to low rates via Crack-dollars from the FEDS. What we don't know going into 2014, how much Dry Power the biggest Mover of stocks has left, Corporate Stock Buybacks on a Grand Scale.

David is making a huge assumption that the GDP print will carry over to 2014 and that the actual economy is getting stronger. If anything, we are due for another pullback across the board. That hasn't yet effected stock prices thanks to Crack-dollars from the FEDS and corporate stock buybacks. Just as investors have quickly forgotten the epic Market crashes of the past, they also tend to get just as fearful if the Markets again have a massive correction.
Jan 1, 2014 5:46PM
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Fast Money mentioned an interesting trend which they say goes back to 1928. If the first 5 trading days of Jan are up, then 76% of the time, the entire month of Jan is also up. If the entire month of Jan is up, than the Markets are up 82% of the time for the entire year.

They also mentioned a major divergence between commodity prices and stock prices that tend to equalize over time. They say the Trend is your Friend until it ends. We shall see.



Jan 1, 2014 2:16PM
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It's been a Great Year....Nice upside on FMVs.

If you weren't playing, you were dying...

We hit records and over 16.5 on DOW..

Other Indices at new Records....

Think there are several opportunities coming in 2014..

Think better Recovery Worldwide..

Energy plays, Heavy Equipment, Medical/Health, Tobacco as always, Big Internationals or Multi's.

Hopefully mining and metals, Rails, Home Improvement, Housing and some Financials.

HNY 2014

ps...Crazy, why is V-L stalking you, his meds aren't working? arf, arf, arf.

Jan 1, 2014 8:43AM
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Folks play the Lottery and go to the Casinos all the time knowing full well the Odds are Rigged against them. You will hear them talk about the Odds of losing compared to winning all the freaking time yet they still go. So what makes some folks think just because a given poster talks about Market Manipulation and or Odds of a Correction those same posters don't invest and or speculate in the Markets? It's a complete falsehood to assume that.

Everyone has different methodologies to investing. Some folks know how to hedge properly while others only know how to Hold to Infinity. There are also folks fully invested but are here just to make political statements.

At the end of the Day, regardless of what the Markets do or don't do in 2014, a wise investor is aware of all the possible outcomes that might play out. A wise investor isn't greedy because we know that eventually, Pigs get Slaughtered.

Jan 1, 2014 4:09PM
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  Tog, My favorite trade around stock SLW offered 6 or 7 chances to pick up 9 to 60% gains last year. Your stock EGO was even better. Of course one is not going to catch them all or all of the swing. It can sure help cover the losses in your core holding however. Expecting more of the same this year. I will be watching EGO closer this year. Could be a jan. effect stk.
Jan 1, 2014 8:14PM
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  Some good points here from Tog, Ntu, Roadhouse, Dave and others. Most every year we mention this could be a interesting year and this year is certainly no different. Yes the January trend has been consistent as has the January effect that I mentioned. This year there is not a lot of serious tax loss selling except in metal and coal stocks so they could have a bounce for a month or two if gold and coal prices hold or increase.


  On the January trend, if the first 5 days were up and you stayed in January through March and out this rest of the year you would have handily  beat the market over the long term and with 9 months less risk. Even more so when your brokerage account was paying 5% or so.


  Congrats Roadhouse on a conservative investment theme that served you well and no your not wrong. Investment styles is what ever is in your wheel house is right. When we get out of our comfort zone to fast is when fast is when we can get in trouble.

 

  NTU, you and I will keep an eye on the new world order for the boys and girls. May or may not be anything largely effecting our investments at our age but if they win over on the idea of sharing our retirement savings with others not only but around the world like they want it will be huge for the next generation. Stay profitable.





Dec 31, 2013 6:26PM
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A economy built on Cheap Crack-Dollars and massive Stock Buybacks as a result is hardly one that's heating up.
Dec 31, 2013 7:48PM
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...



Now let's see ?   We had the market collapse in housing in 2006 and historically within 7 years of the housing collapse you have the stock market collapse.  It looks like were over due for a terrible market adjustment.   But, who cares?  You can make a lot of money "Selling Short" if you know what you are doing.

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