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Mark Hulbert
May 17, 2011, 12:01 a.m. EDT
By Mark Hulbert, MarketWatch
CHAPEL HILL, N.C. (MarketWatch) "” Investors who want to understand the likely impact of QE2's end this coming June 30 would do well to focus on companies like MAKO Surgical.
This medical device company, with a tiny market cap of just $986 million, has lost money in every year since its initial public offering in early 2008. It has a sky-high price-to-book ratio of greater than 9-to-1 and, needless to say, pays no dividend.
The stock of MAKO Surgical /quotes/comstock/15*!mako/quotes/nls/mako MAKO +15.78% has gained 57% so far this year.
Contrast that with Wal-Mart Stores /quotes/comstock/13*!wmt/quotes/nls/wmt WMT -1.07% . One of the world's largest companies, Wal-Mart has made money for many years in succession "” even throughout the Great Recession. Its dividend yield is 2.6%, and has a price-earnings ratio that is below that of the broad market. Its price-to-book ratio is below 3.
Wal-Mart stock's year-to-date gain, including dividends: 5.2%.
Just goes to show that no good deed goes unpunished...
Nor are these two companies' experiences unique. Consider two groups of stocks at opposite ends of the junk-versus-quality spectrum: Small-cap growth (which is relatively close to the junk extreme) and large-cap value (which is relatively close to the quality extreme). As judged by the Russell 200 Value and Russell 2500 Growth indices, junk continues to lead the market "” just as it has, on balance, since the bull market began more than two years ago.
Had this bull market conformed to the historical pattern, then we would have expected that this junk-over-quality pattern would have lasted only a matter of months following the end of the bear market in March 2009. Since the lowest-quality companies were among the biggest casualties of that bear market, it would have been entirely normal that they would jump back the most when the economy showed signs of recovering.
But once that snap-back rally "” some might say "dead cat bounce" "” had played itself out, market leadership should have begun to shift to higher-quality companies. Historical precedent suggested that this transition should have begun at least by the time the bull market was one year old.
Why didn't it "” and why has it not still?
One compelling answer comes from Jeremy Grantham, chief investment strategist at Boston-based GMO. He argues that the second round of quantitative easing (QE2), and the various other stimulus programs that preceded it, amount in effect to a government subsidy in favor of risk-taking. It is hardly surprising, therefore, that junk has continued to outperform quality for far longer than otherwise expected.
What will happen when investors realize that this government subsidy program is coming to an end? The stock market presumably will re-price the lowest-quality stocks to take into account the greater exposure to downside risk.
And when that happens, the highest-quality issues like Wal-Mart should be the market's leaders.
Forecasting when this transition takes place is not an exact science, of course, since it depends on a whole host of factors "” such as whether there will be yet another round of stimulus, or QE3. But, eventually, it seems safe to say, the shift in leadership will have to take place.
Indeed, according to Grantham, he is hard pressed to find other times in U.S. stock market history when quality (large-cap value) has been as undervalued as it is today, relative to junk (small-cap growth).
Over a several-year time frame, in fact, he thinks it is a safe bet than large-cap value stocks will not only perform well in their own right, but especially relative to the small-cap growth sector.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
"Mark Hulbert: Junk continues to lead the market http://on.mktw.net/jClF9c" 11:40 p.m. EDT, May 16, 2011 from MktwHulbert
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Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now.
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