Bespoke: When it comes to high- vs low-quality stocks, perspective is key

Published Thu, Jun 9 20161:38 PM EDT

Paul Hickey, Bespoke Investment Group co-founder

We've discussed the performance of equities based on their credit ratings quite often over the last several years. In the early stages of the bull market, the list of outperformers was dominated almost in its entirety by low-quality stocks. Beginning in late 2014/early 2015, the relative performance of lower-quality stocks leveled off, and after peaking in early 2015, began to deteriorate ahead of the peak in the S & P 500 . That underperformance continued right up until this past February at which point low-quality stocks bounced and bounced hard. In our most recent update on credit quality from Feb. 17 just after the February lows, we highlighted the shift in performance where low-quality stocks were leading in the initial days of the rally. Today, we wanted to update the performance figures to see how things have played out. For this analysis, we have grouped stocks in the S & P 500 based on their credit ratings (at the start of February) and calculated each group's average return over the last year, year to date and since the February lows. Source: Bespoke Investment Group Looking at performance over the last year, there is a clear trend of high quality equating to higher returns. Stocks with AAA credit ratings in early February, of which there were only three ( JNJ , MSFT and XOM ) and now only two (XOM has since been downgraded), have outperformed over the last year with a gain of 13.22 percent. As you go down the quality ladder, performance steadily declines to the point where junk-rated stocks are the worst-performing group with a decline of 4.12 percent. Year to date, performance is more evenly divided, but since the February lows we have seen a complete shift where the three baskets of stocks with various A ratings (AAA, AA and A) are up either half as much or less than half as much as the basket of junk-rated stocks. More from Bespoke : Jobless claims resume downward trend Rather than just showing the static returns of high- (AA and AAA) versus low-quality (junk) stocks at various points in time, the chart below shows their performance over the last year. Up until last fall, both baskets of stocks were performing in line with each other, but when the S & P 500 rallied off of the double bottom in October, low-quality stocks went limp. While the S & P 500 and higher-quality stocks saw decent returns leading up to the FOMC hike in December, low-quality stocks continued to slide lower. By the time February rolled around, junk-rated stocks were down nearly 25 percent since early June 2015, while higher-quality stocks were down by just a little over 5 percent. People often say that individual stocks are highly correlated, where a tide lifts or drags down all boats, but during this stretch, there were wide disparities in performance among individual stocks. Source: Bespoke Investment Group Since February, both baskets of stocks have rallied nicely, and while it may be hard to see in the chart, lower-quality stocks have been the clear leaders even if they are still down over the last year. Using a relative strength chart of each basket relative to the S & P 500 clearly highlights the overall shift to lower-quality stocks (rising red line) as higher-quality stocks have underperformed (falling green line). For a lot of investors and managers out there, the last four months have likely been frustrating as various metrics suggest they have underperformed during this rally. Perhaps the more important takeaway, though, is that even as high-quality stocks have lagged over the last six months, the gap in performance between them and lower-quality stocks over the last year is still wide. It all comes down to perspective and time frames, and over multicycle periods, higher-quality stocks have withstood the test of time. Source: Bespoke Investment Group For more independent commentary and analysis from Bespoke, visit bespokepremium.com/

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