Odds favour long-term growth stocks set to pros

The stock market's gyrations this week are guaranteed to confuse. No one appears to know where the market is headed and pundits' views are disproved daily, a reminder that forecasting is rarely anything but a mug's game.

Political worries, conflicting economic statistics, weak consumer demand and a raft of profits down- grades seem at odds with the Footsie nudging its all-time high. What appears to be keeping it at these levels is a combination of feverish bid rumours and strong institutional cashflows.

For most investors, judging the next move of the market as a whole is of academic interest only. Of more practical use is judging correctly which areas of the market are likely to benefit most at any given point in the economic cycle. That is the key to investment strategy.

BZW, the investment banking arm of Barclays, believes we are at a watershed in the cycle, the end of the recovery phase which followed recession and the beginning of a period that will favour long-term growth stocks at the expense of cyclical recovery plays.

The firm argues that the recent spate of profit downgrades which accompanied often disappointing interim results announcements is actually only a pause in growth. The next upward push will be driven by easing input price pressures next year, rising margins (which are still below the last peak) and the benefit of cost-reduction programmes since the recession.

Consumer stocks look less attractive than industrial companies. As a result of low inflation, the ability to improve prices will also be less of a factor and the best-placed companies over the next stage will be those that invested heavily to cut costs and become more efficient.

Other likely features of the next stage in the cycle are expected to be some broadening of the range of price/earnings ratios, which is narrower currently than for 30 years. That will also favour long-term growth stocks as earnings growth potential is more highly valued than simple recovery from recession.

The final beneficiaries of the second part of the cycle could also be smaller companies, which performed so well in the latter part of the 1980s. Almost by definition they offer greater growth prospects than larger companies and currently they suffer from low valuations as a class.