There has been much debate about whether or not the sell-off of the last three weeks is the start of a new bear market, or simply just a correction that should be bought. Regardless of which camp you are in, the logical step is to figure out what type of asset allocation will be best, and I think both trains of thought lead to buying large-cap growth stocks.
Think back to the end of 2005, and how many market pundits were calling for large-cap value stocks to shine in 2006, taking the place of small-cap stocks that had been rallying ahead of the market for the previous several years. Since the start of 2006, large-cap value measured by the iShares S&P 500 Value Index (NYSEARCA:IVE) has outperformed large-cap growth (NYSEARCA:IVW), 15% to 5%. So by and large, those predictions came true, meaning we have seen a small-cap rally and a large-cap value rally in this bullish cycle.
The tendency for market sectors to undergo a reversion to mean, combined with my relatively negative economic outlook, make me think that growth stocks - specifically the larger companies that haven’t already seen valuations skyrocket - will likely be the next group to outperform. Large-cap growth should have the stability that investors are looking for in risky times, while still providing the bottom-line growth required for stock price appreciation. The long string of double digit earnings increases the market has seen seems to have lessened the value of growth, and a tough economic landscape would likely bring investors to really reward the consistent 10%+ plus earnings growers.
A few large-cap growth stocks I like right now include biotechnology company Amgen (NASDAQ:AMGN), computer maker Dell (DELL), United Technologies (NYSE:UTX), and South African-based energy company Sasol (NYSE:SSL).
AMGN in particular has been hit hard of late, and now trades for less than 18x free cash flow. Given its strong pipeline, great margins, and low industry valuation, I believe AMGN is one of the most oversold stocks in the market today. Right now the worst case scenario for many of the uncertainties surrounding the company looks to be priced in, so the stock should have limited downside and should jump on any sort of positive news. My valuation model says AMGN is worth upwards of $75/share.
AMGN 1-yr chart
Investors also seem to be discounting the ability of Michael Dell to turnaround his namesake company. DELL trades for less than 13x FCF right now, and if Dell demonstrates an ability to leverage its low-cost manufacturing process to capture a share of fast growing foreign markets, the stock should see a good rebound. I value DELL at more than $26/share.
DELL 1-yr chart
Although I feel the markets have several more weeks of selling to do before this correction is through, scaling into large-cap growth over the next month or so should provide an excellent cost basis for delivering market-beating returns. Large value has been getting expensive. Large growth has been getting cheap. I think a reversal in fortunes is in order.
Disclosure: Author has no position in any of the above-mentioned securities.