Bearish investors are switching to quality stocks

Quality shares are seen as being safe bets, particularly in times of economic uncertainty.

One of the big stories this year has been the value and cyclical rally. After a long period of underperformance, value shares spent much of the first half of the year outperforming growth and quality shares.

There is a lot of overlap between value stocks and cyclical stocks. Therefore, with economic expectations optimistic, value and other pro-cyclical stocks edged ahead.

However, in recent months, this value rally has started to run out of steam. Increasingly, investors have been turning back to growth and quality stocks. This, especially in regard to the latter, may suggest investors are now more bearish.

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As of 19 July, the year-to-date return for the MSCI World Quality Index stands at 14.1%, in sterling terms. It has outpaced the MSCI World Value Index, which has returned just under 12%. The same trend has played out in the US;  the MSCI USA Quality Index has returned almost 15%, while the MSCI USA Value Index is up 13.6%.

This potentially suggests that investors are getting more bearish and doubtful about the economy’s growth prospects. Economic data in both the US and China, the world economy’s two core engines, appears to be weakening. At the same time, there is growing concern about the spread of the Delta variant of Covid-19.

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Quality is a so-called factor. A factor is a common characteristic shared by a set of shares. In the case of quality, this means shares in companies that have a proven record of sustainable profits and a strong balance sheet. These shares are seen as being safe bets, particularly in times of economic uncertainty. While quality stocks do not perform so well when the economic outlook is good, they are dependable. Therefore, if investors are bearish on the outlook for the global economy, it makes sense for quality stocks to now be back in favour and outperforming.

The increasingly bearish outlook of markets can also be seen in the most recent Bank of America Merrill Lynch Global Fund Manager Survey, which we reported on here.