For US stocks, growth trumps quality
Investors bracing for market dynamics to change
NEW YORK, Sept 30, (RTRS): US investors are not rewarding companies for generating good earnings consistently, opting instead for a stockpicking strategy that might be called “growth at a high cost.”
High-quality stocks selected for their strong balance sheets and stable earnings have appreciated just 12 percent this year, according to Goldman Sachs Group Inc, while the broader S&P 500 benchmark index has returned 13.8 percent.
But investors cannot seem to stop throwing money at companies improving their sales fastest: a group of such equities tracked by Goldman Sachs has surged 20 percent.
Put another way, discriminating investors who have chosen companies with stable earnings prospects are being punished.
This lagging interest in quality stocks has even whipsawed wellknown fund managers; Whitney Tilson said this week he was shutting down his Kase Capital Management LLC hedge fund.
“Historically, I have invested in high-quality, safe stocks at good prices as well as lower-quality ones at distressed prices,” Tilson wrote to investors.
“Given the high prices and complacency that currently prevail in the market, however, my favorite safe stocks (like Berkshire Hathaway and Mondelez) don’t feel cheap, and my favorite cheap stocks (like Hertz and Spirit Airlines) don’t feel safe. Hence, my decision to shut down.”
Yet some managers are betting that complacent markets could be shaken from their zombie-like slumber as easy monetary policy and its backdrop of lower interest rates comes to an end.
“In an environment like we’re in now - where no one really cares what things are worth - you may underperform, but over time reality will set in,” said Sean O’Hara, director at Pacer Financial Inc. “It always does.”
O’Hara said quality investments underperform when investors are willing to buy stocks without regard to their value, and that markets have been supported by the US Federal Reserve’s extraordinarily loose policies.
Earlier this month, the Fed, as expected, said it would begin to reverse some of those policies by gradually reducing its bond holdings.
Pacer Financial is one of a several investment firms betting that quality will matter again. Its “Cash Cows” ETFs buy companies with strong cash flows and healthy balance sheets.
Goldman Sachs’ global investment research unit included companies such as retailer Ross Stores Inc, pharmacist CVS Health Corp and oil driller Schlumberger NV in its high-quality group earlier this year.
Yet these companies have mostly not been star performers.
The market has been led by socalled “FANG” stocks - like Facebook Inc, Amazon.com Inc, Netflix Inc and Google parent Alphabet Inc - and a small winner’s circle of lesser-known names like Celgene Corp and Equinix Inc.
These companies have all enjoyed robust sales growth in a US economy that’s below its boiling point, even as many factors disqualify some of them as quality stocks.
Netflix has had 12 straight quarters of negative free cash flow, and the company warned it may not see positive free cash flow “for many years” as it invests in original content like the science-fiction drama “Stranger Things.”
With the Fed’s interest-rate hiking cycle taking hold, investors are bracing for market dynamics to change.