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Stocks have traded in a relatively narrow range for the past two weeks, but beneath the surface, 2014 is shaping up to be a year of reversals across the investment landscape.

In other words, some of last year’s winners are shaping up to be this year’s losers. In particular, as I write in my new weekly commentary, I see two shifts happening, one in the equity market and one in the bond market:

1. Equity investors are rediscovering their appetite for value. The market appears to be experiencing a rotation away from growth and into value styles, with glamorous, high-momentum types of stocks appearing to be less in vogue.

Just one example: the U.S. biotechnology industry was up roughly 65% last year, but is now down 15% from its peak in February. Overall, large-cap value stocks have gained roughly 1.25% over the past month, while growth equities have lost more than 2%.

This rotation is being driven in part by the fading of the momentum trading theme (which favored growth styles). It’s also a result of a growing discrepancy in relative valuations. As of the end February, growth stocks were trading at nearly a 40% premium to value stocks, significantly higher than the 10-year average of around 25%.

 2. Rate volatility has been highest in short- and intermediate-duration bonds. While last year investors did well to avoid long-dated Treasuries, this year the damage is more in the short- to middle-part of the Treasury yield curve. This section of the curve is proving the most vulnerable given growing concerns over an earlier Federal Reserve (Fed) rate hike.

Whereas the yield on the 10-year Treasury has barely moved over the past couple of weeks, the yield on the five-year Treasury has jumped from 1.53% to 1.73%. Looking ahead, we expect this area of the Treasury yield curve to experience the most volatility, and also to be the most sensitive to expectations of a potential increase in the federal funds rate.

So what does this mean for investors? There are a few implications.

Should the shift to value from growth continue, beneficiaries are likely to include U.S. large- and mega-cap stocks and potentially U.S. financial sector shares.

In addition, investors should continue to expect outsized volatility in the two- to five-year part of the yield curve. You can read more about my equity and bond outlooks in my Investment Directions monthly market commentary.

 

Source: Bloomberg, BlackRock research

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.

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