Don’t get the wrong impression, levered companies have rebounded from the market hellfire in December, and continue to find a bid. It’s just investors keep on pumping up quality equities on the belief that stable earnings and lower debt will reduce the volatility of their portfolios, and help them outperform in any economic downturn.
That’s raising an uncomfortable question: Are they worth it?
The premium between global quality and value stocks is jumping back to multi-year highs. U.S. equities with strong balance sheets trade at about 25 times forward estimated earnings, compared with 12.5 times for those with weaker financial profiles, Goldman Sachs indexes show. The kind of valuation gap sits in the 94th percentile based on data going back to 1980, the bank said in a note this month.
All that combined with firmer risk appetite spurred Goldman strategists to reverse their two-year overweight recommendation on strong balance sheets earlier this month.
Hunker Down
At Legal & General Investment, Andrzej Pioch is staying neutral on quality firms, a factor with a wide range of definitions from low debt to strong earnings prospects. The money manager at the $1.3 trillion firm is sanguine on valuations, particularly on cash flows and book value, but market sentiment makes him “uncomfortable.”
Surveys Pioch cites suggest investors haven’t been this optimistic about the factor since late 2015, when deflationary fears stalked the world economy.
In other words, more money managers are becoming price-agnostic in their rush to hedge.
“I think it’s less about projecting where the market is going and what’s going to be the big winner, and more about building resilience into a portfolio in an event of a potential downturn,” said Holly Framsted, head of U.S. factor ETFs at BlackRock.
Michael Hunstad of Northern Trust Asset Management is playing defense. He’s helping to screen the fund’s $1.1 trillion of assets overall for equities that offer balance-sheet strength as well as asset turnover, a measure of corporate efficiency.