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Value Stocks to Lead Next Market Leg Quant

Friday, 30 Apr 2010 | 11:46 AM ET

Just in time for Berkshire Hathaway's Annual Meeting this weekend, Warren Buffett's brand of value investing may be ready to take over for the high-risk strategy that has been in favor over the last 12 months.

"Over the last 25 years, there have been three other beta rallies like what we have seen recently," wrote Savita Subramanian, a Bank of America Merrill Lynch quantitative strategist, in a note to clients. "After each of these periods, value strategies consistently took the lead in the subsequent leg of market performance."

The S&P 500 is up 38 percent in 12 months, led by outsized gains in stocks such as once-troubled insurer Genworth Financial, downtrodden media company Gannett and a consumer-leveraged Internet company, Priceline.com.

Beta measures the risk of a security versus the overall market. Genworth, the top gainer in the S&P 500 since last April, has a beta over three, meaning that for every 1 percent move in the index, this volatile stock fluctuates by more than three times that amount.

In a simple and easy-to-understand manner, Subramanian broke strategy performance down into three groups: beta, value, and quality. The analyst determined which stocks belonged in the value category by looking at their price-to-earnings ratios relative to the rest of the index. Quality stocks were distinguished by their relatively high return on equity ratios.

Following outperformance by so-called beta names from 1990 to 1992, 1996 to 1999 and 2002 to 2004, value-oriented stocks always took over the lead next. Subramanian's breakdown was contained in a report where the analyst pointed out that formula-driven quantitative funds have already begun a shift from riskier names into value right now.

"The most pronounced tilt of quant funds was toward statistically inexpensive companies," wrote Subramanian, who analyzed a sample of U.S. Large Cap Quantitative Equity Funds for their holdings. "A tilt toward valuation and away from beta is currently appropriate, in our view."

Exxon, which fell after disappointing earnings on Thursday, has a beta of 0.4, meaning that for every move in the index, it barely budges. The forward P-E of the world's largest publicly-traded company, is 11, below the market's average multiple.

"If the market is going to go higher, it's now going to be led by value," said Anthony Scaramucci, founder of SkyBridge Capital. "We've had such a huge jump in the junk, in such a short time."

Scaramucci, author of the forthcoming book 'Goodbye Gordon Gekko', recommends picking up shares of Pfizer, which sport a forward P-E of 8 and are off six percent this year.

Warren Buffett will meet with over 40,000 shareholders in Omaha, Nebraska this weekend, an annual ritual that attracts passionate followers of the legendary investor's value style. Buffett's top stock holdings include Coca-Cola, Procter & Gamble and Kraft.

For the best market insight, catch 'Fast Money' each night at 5pm ET on CNBC.

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Trader disclosure: On Apr 30, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Adami Owns (AGU), (C), (GS), (INTC), (MSFT), (NUE), (BTU); Najarian Owns (AKAM) Call Spread; Najarian Owns (PG) Calls; Najarian Owns (JEF) Calls; Najarian Owns (KGC) Calls; Najarian Owns (C) Calls; Najarian Owns (CBS) Calls; Najarian Owns (NRG) Call Spread; Najarian Owns (TEVA); Najarian Owns (YHOO) Call Spread; Grasso Owns (NDAQ), (DYN), (LPX), (ASTM), (ABK), (BAC), (BGP), (C), (CVGI), (JPM), (NEM), (PRST), (PFE), (BA), (T), (CSCO), (X); Stutland Is Short (SPY) Through Options; Stutland Owns (XLF) Call Spread, Is Short Strangles, Is Long Downside Put; Stutland Owns (CVX); Stutland Owns (WFC) Corporate Bond; Stutland Is Short (BAC) Straddle, Owns (BAC); Stutland Is Short (GLD) Put Spread, Is Long 1x2 Call Spread; Stutland Owns (SLV) Calls, Is Short (SLV) Puts; Stutland Owns (TXN), Is Short (TXN) Call; Najarian Owns (PG) Calls; Seymour Owns (EEM), (AAPL), (BAC), (GOOG) (MSFT); Finerman's Firm Is Short (IWM), (IYR), (MDY); Finerman's Firm Is Long S&P Puts; Finerman Owns (AAPL), (AKAM); Finerman's Firm Owns (BAC), (BAC) Leap; Finerman Owns (BAC), (BAC) Preferred; Finerman's Firm And Finerman Own (CVS); Finerman Owns (GOOG); Finerman's Firm And Finerman Own (JPM); Finerman's Firm Owns (KFT); Finerman Owns (WFC) Preferred; Finerman's Firm Owns (BBY); Finemran's Firm Owns (BP), (BP) Calls; Finerman's Firm Owns (RIG), (RIG) Calls; Finerman Owns (BBY); Finerman Owns (RIG), (RIG) Calls

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  Price   Change %Change
S&P 500
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BRK.A
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GCI
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GNW
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MDLZ
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KO
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The Priceline Group
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PG
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XOM
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PAA NAT GAS
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