After a broad rally that pushed major stocks and cryptos near new highs, some investors are lifting purchase levels.
Quality stocks - Wall Street is hunting for - are broadly defined as shares of companies with some combination of growth, reliable profits, and strong balance sheets. The list includes recent highfliers such as Microsoft and Nvidia to steady performers such as Coca-Cola and Johnson & Johnson.
Why do investors shift as the market rallies?
High-quality companies tend to do better than others when growth slows—the environment much of Wall Street expects this year—insulated by their steady financial results, low debt, large cash holdings, or other solid business fundamentals.
The MSCI ACWI Quality Index has historically beaten MSCIs global index by 1% point over six-month periods in which the economy has cooled but kept expanding, according to UBS analysts.
That reliability tends to make quality stocks relatively expensive, which means investors might miss out on some gains in a big rally. But for those concerned that the recent surges in stocks and bonds wont last after a rocky start to the year, seeking quality provides a way to stay invested while potentially cushioning against some of the blow if markets turn. The S&P 500 is almost flat YTD to start 2024.
The iShares MSCI USA Quality Factor exchange-traded fund gained 29% in 2023, according to FactSet, ahead of the S&P 500s 24% climb.
Some research shows that quality stocks do provide better returns after accounting for risk. A 2013 paper by AQR Capital Management found that despite the higher costs, there are strong and consistent abnormal returns to quality, and that a strategy of betting on quality stocks and against shares of weaker companies would earn significant returns in the U.S. and elsewhere.
Michael Reynolds, vice president of investment strategy at Glenmede, said his firm has taken a tilt toward quality. Despite economists optimistic outlook on U.S. growth, fears of a recession remain elevated, he said.
We look at the past five or six bear markets, and quality has outperformed as a factor, and quality stocks tend to be solid performers in periods of market stress around recessions, he said.