10 FTSE 100 momentum stocks for uncertain times

Stock screen expert Ben Hobson studies one of the most eye-catching strategies for investors hunting ideas in a volatile market and comes up with some possible opportunities.

Unlike most major Western stock markets this year, the UK’s FTSE 100 has held up fairly well. At just 3.3% down, it has avoided the double-digit losses seen in the US and across Europe. Its unusually strong mix of shares in energy, banking and defensive industries such as pharmaceuticals and consumer staples have propped it up, while the rest of the market is on its knees.

Faced with rising inflation and the knock-on impact of higher interest rates, this solid performance from blue-chip shares makes sense. Oil and gas producers are benefiting hugely from soaring global energy prices. So, too, are the national utilities which route that energy to households.

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Elsewhere, and after more than a decade of financial stimulus from the Bank of England, UK banks have been the obvious early winners from recent interest rate hikes. Their corporate and consumer loans and mortgages are now much more profitable than they have been for some time. Even the traditional sin stock industries such as tobacco and defence have done well this year - benefiting respectively from a boom in vaping and a war on mainland Europe.

Elephants don’t (usually) gallop

The large-cap outperformance that we’ve seen recently is actually at odds with the long-term trend in stock markets. A so-called size effect was first documented in the early 1980s. It describes the fact that small company shares, although more volatile, tend to outperform large ones over time. This is partly why smaller-cap shares are so popular with individual investors.

Jim Slater, a legendary name among British growth investors, once summed up the size effect with the phrase “elephants don’t gallop”. But while it’s true that large-caps tend to be at the more mature end of the growth cycle, it doesn’t mean they can’t enjoy strong momentum in both earnings and share prices - and that’s exactly what we’re seeing now.

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As a driver of returns, momentum is one of the most powerful factors in markets. Research shows that stocks outpacing their forecasts and seeing their prices rise higher often benefit from those trends persisting into the medium term. Against a backdrop of no certainty about where inflation will go, or whether a recession is on the cards, there’s a case for thinking that British large-caps will continue to benefit.

On top of that, companies that derive all or part of their income in US dollars - but report in British pounds - are currently benefiting from an extra tailwind. Currency diversification like this is fairly common in large FTSE 100 companies operating around the world. And because the dollar has strengthened against the pound this year, those companies are benefiting from the forex uplift.

So where have the best performances been this year? This screen simply looks for large-caps where earnings have grown in the last year and are forecast to grow again in the coming year. The list is sorted by relative price strength against the market - and also shows the current dividend yields on offer.

One of the big takeaways from this snapshot of fast-moving blue-chips is how high some of the percentage earnings per share (EPS) increases are expected to be in the next year. This is obviously one of the moving parts in the story of spiralling energy prices and the cost-of-living crisis. You can see that for energy producers such as Shell (LSE:SHEL)and BP (LSE:BP.), and utilities such as Centrica (LSE:CNA), the owner of British Gas, that earnings are growing at exceptionally high rates.

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That growth has translated into strong price momentum, and they’re still on dividend yields of 3.5%, 4.2% and 3.0% respectively, as well as low single-digit price/earnings (PE) ratios. While fossil fuels have fallen well out of favour, it’s still eye-catching how cheap these shares look versus recent and expected earnings performance. That said, we know that global energy prices are exceptionally and perhaps temporarily high right now, and that government intervention is on the way. So those valuations reflect that uncertainty.

Likewise, traditional sin stocks such as defence group BAE Systems (LSE:BA.) and tobacco companies British American Tobacco (LSE:BATS) and Imperial Brands (LSE:IMB) have all seen 20%-plus share strength against the market this year. Investors have gravitated to dependable cash flows in what are often financially robust, reasonably priced, high-yielding shares.

Where next for the blue chips?

Overall, the extreme macro conditions that have played out over the past year have worked in favour of a number of FTSE 100 companies. At times of heightened economic uncertainty, high yield large-caps often end up being one of the safer havens anyway. When you add to the mix rising inflation, higher interest rates, an energy crisis in Europe and a strong US dollar, British blue-chip companies clearly become appealing, and that’s why investors are buying them.

With so much uncertainty still ahead, it’s fair to say that some sectors, particularly in energy and utilities, will be watching very closely to see how governments at home and abroad tackle the issue of soaring prices. But for now, large-cap momentum continues to be one of the most eye-catching strategies for investors looking for ideas in a volatile market. There could be many more opportunities out there for Britain's biggest stocks.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.