The crowd is chasing high-beta homeruns. But the rally off the April lows has left high-quality stocks behind as speculative names have outperformed – and those high-quality stocks are the big opportunity right now, notes Alec Young, contributor at MoneyFlows.
Despite strong fundamentals, “best of breed” stocks like Apple Inc. (AAPL), Visa Inc. (V), Coca-Cola Co. (KO), Eli Lilly and Co. (LLY) and Costco Wholesale Corp. (COST) have lagged, while unprofitable Artificial Intelligence, robotics, quantum, and nuclear momentum plays have soared.
The S&P 500 Quality Index tracks the 100 highest quality S&P 500 names as measured by their S&P Quality Ranking. It has trailed the S&P 500 by 9% over the last six months, marking one of its weakest stretches of underperformance ever. But the quality factor’s sector composition offers a winning combination of offense and defense that’s well suited to current market conditions.
Quants define high-quality stocks as those with the following fundamental attributes:
- High returns on equity
- Stable year-over-year earnings growth
- Low financial leverage (debt)
With positive attributes like that, it’s no surprise quality never goes out of style for long. Buying the dip in high-quality blue chips has consistently paid off since 2005.
Bull markets rotate as they rise with numerous leadership handoffs throughout the cycle. Recent action is a case in point. Quality defensive names in health care, energy, staples, and real estate have finally perked up as long-standing cyclical leaders in tech, financials, utilities, and industrials consolidate their massive gains.
Market rotation will benefit the quality trade because it’s much more diversified than the broader S&P 500. Think of quality as a higher-yielding portfolio that still captures 94% of the S&P’s upside over the past decade with only 95% of the volatility. And if you buy it when it’s on sale, you can beat the S&P to boot. That’s a powerful 1-2 punch!
