|
Published: February 10, 2010
Investors have suffered through 14
bear market plunges in the post-WWII era. Fortunately, those
declines have been followed by 14 bull markets.
The bounce-backs are typically far more powerful, but predicting
the inflection points with accuracy can be difficult. From a
historical standpoint, stocks have delivered an average return
of +22% in the four months before the economy shows signs of
recovery. So waiting around for too many "green shoots" can be
costly.
Of course, we all know the current story: a broad recovery has
lifted pretty much everything higher. It has been a great ride,
to be sure. But these massive rallies have led to some
second-guessing.
Fortunately, while it might seem that virtually every ticker
symbol from here to China has shot skyward and is now out of
reach, there are many stocks that called in sick during the 2009
rally.
Believe it or not, there were more than 507
U.S. traded stocks that could only manage single-digit returns
last year, and 2,296 actually lost ground. That means a large
swathe of the market was either late to last year's party, or
missed out altogether.
When the market zoomed last year, investors began flocking to
the most volatile stocks available. And why not? They stand the
most to gain when traders are in a buying mood.
Billions of dollars in assets flowed into lower-quality stocks
(i.e. companies with weaker competitive positions, more debt,
etc.). The companies with the most question marks were severely
oversold in the downturn -- and thus bounced the furthest once
it was clear that the sky wasn't falling.
While the "junk rally" raged, investors almost forgot about
sturdy blue-chippers like IBM (NYSE: IBM) and Procter
& Gamble (NYSE: PG), which drifted only modestly higher.
I've seen a number of different studies on the phenomenon. While
the criteria might change, they all tell the same story...
- Last August, Morningstar reported that rock-solid
companies with wide moats climbed just +4.8% from their
lows, versus +16.6% for those with narrow moats and +26.1%
for firms with no moats. In other words, the fewer
competitive advantages and barriers to entry for a company,
the sharper the bounce in stock price.
- In 2009, reliable dividend-paying members of the S&P 500 posted an
average gain of +26.2%, while non-payers rung up much
stronger returns of +65.3%.
- Last October, using measures like return on equity, Citigroup found
that companies ranked 'C' and 'D' (the lowest two
categories) outperformed the highest-ranked stocks by a
margin of +55% to +11%.
- Ford Equity Research recently determined that stocks representing the
highest quintile in terms of earnings quality have bounced
an average of +66% from their lows, less than half the +152%
surge in stocks belonging to the lowest quintile.
I've seen other studies based on factors
like dividend yield, debt-to-equity ratio and earnings
revisions. They all point to the same trend: the stronger the
company, the more investors have ignored it.
All of this has turned the usual investment paradigm upside
down. Imagine walking into the supermarket and seeing ground
chuck priced at $5 a pound, right next to filet mignon for $4 a
pound. That's pretty much what the market offers us today.
The last time we witnessed a junk rally this pronounced was in
the early 1970s.
Now is the time to
overweight your portfolio with high-quality stocks. I'd
start shopping in the Dow Jones aisle (this could be a great
time for the "Dogs
of the Dow") and work outward from there.
Good Investing!
-- Nathan Slaughter
Editor
StreetAuthority Market Advisor
The ETF Authority
Half-Priced Stocks |
