ANALYSIS-Quality in after investor binge on cheap assets
Published: Tue, 25 Aug 2009 18:53:29 GMT Hits: 4913
LONDON, Aug 11 - The blanket rally in equities and credit that has dominated trading since March is coming to an end, paving the way for a pickier, micro-based approach that should allow better-run companies to once again outperform.
A search for quality is getting under way in both equity and credit markets that is markedly different from the broad-based risk chasing that has lifted nearly all stocks and squeezed spreads from investment grade to junk.
The rally that began in March and that has driven MSCI's all-country world stock index up about 58 percent has been based primarily on investors' reacting to early signs that the global economy may be on the mend and on buying a broad swathe of heavily oversold stocks.
Indeed, at the initial stage of the rally, those stocks most battered by the market crash fared better.
U.S. investor GMO calculates that the 40 stocks in the S&P 500 with prices above $50 rallied 21 percent on average between March and April. The 50 stocks with prices below $5 rallied 115 percent.
Credit markets have seen a similar trend with Bank of America-Merrill Lynch's once battered global high-yield bond index gaining some 45 percent since March.
Now, however, investors are looking for the cream to rise to the top.
"Long quality (or long quality and short junk) is substantially the most outlying bet available today in all global equities," GMO Chairman Jeremy Grantham wrote to the firm's clients.
Part of the reason, at least on equity markets, is that investors are showing signs of looking beyond outside factors such as global economic growth, and instead focusing on internal features such as earnings potential.
"Stock price movements have begun to return to more normal levels, and have recently been less driven by macro factors and more by security-specific factors," Bob Doll, BlackRock's global chief investment officer for equities, said in a recent note.
He sees compelling value in higher quality companies that have relatively strong balance sheets, healthy levels of cash flow and adequate financing.
While quality seems to be the buzzword, this does not necessarily mean just big names, according to James Thomson, fund manager at Rathbones.
He focuses on mid to small, largely undiscovered, quality companies which have high growth potential, avoiding mainstream firms and retaining flexibility by not tracking benchmarks.
"The most important decision is to buy right companies. They will be more volatile, high beta. It's the price to pay for getting higher returns," Thomson said.
JUNKED JUNK?
Within the credit space, investors are also taking a more discriminating approach after buying the asset class across the board, tightening spreads which had blown out at the height of the crisis.
Barclays Capital is recommending investors burrow down deeper into corporate paper and set short positions in credits that are likely to face micro risks. It cites as examples debt issued by Valero Energy, Motorola, GATX Corp and RR Donnelley.
Barclays says Valero Energy faces headwinds from carbon legislation, while Motorola and RR Donnelley face competitive pressures and GATX Corp could issue new debt.
On the other hand, European good quality credits look set to extend their rally with Schroders estimating their spreads relative to government bonds in cash are still around four times higher than they were at the peak of the credit cycle.
This, Schroders says, leaves room for high quality spreads to tighten by as much as another 75 percent from here.
"We believe the case for good quality corporate bonds continues to look extremely compelling," Adam Cordery, fund manager at Schroder, said.
