Seeking Alpha
Registered investment advisor, CFA, portfolio strategy, macro
Profile| Send Message|
( followers)  

Stock investors have certainly endured a wild ride that has included extreme volatility and periods of traumatic downside over the last several years. But stocks boasting two key characteristics have enjoyed a far more placid and rewarding experience than the broader market since the beginning of the financial crisis.

What are the two key characteristics? High Quality and Low Volatility

In order to demonstrate how stocks from these two distinctive categories have rewarded investors over the last several years, it is worthwhile to examine returns over the following distinct time periods:

9/12/08 - 3/9/09: The Lehman collapse to the stock market bottom

3/9/09 - 3/31/10: Stock market bottom to the end of QE1

3/31/10 - 8/26/10: End of QE1 to Bernanke's Jackson Hole speech confirming QE2

8/26/10 - 6/30/11: Jackson Hole speech to end of QE2

6/30/11 - 10/3/11: End of QE2 to launch of Operation Twist

10/3/11 - 12/21/11: Launch of Operation Twist to launch of ECB's LTRO

12/21/11 - 2/29/12: Launch of ECB's LTRO to end of ECB's LTRO

2/29/12 - 6/27/12: End of ECB's LTRO and return to Operation Twist only

For the purposes of this analysis, the broader stock market will be measured by the S&P 500 Index (NYSEARCA:SPY).

HIGH QUALITY

The analysis will begin with a comparison of returns of the broader stock market versus High Quality stocks. To standardize the representation of High Quality stocks, the analysis will focus on the S&P 500 High Quality Rankings Index (NYSEARCA:SPHQ) that focuses on those members of the S&P 500 Index that are ranked among the best in regards to the growth and stability of earnings and dividends. More specifically, these are stocks that have an S&P Quality Ranking of A- or better.

Date

S&P 500

High Quality

+/- High Quality

9/12/08 - 3/9/09

-46%

-48%

-2%

3/9/09 - 3/31/10

73%

83%

+10%

3/31/10 - 8/26/10

-10%

-6%

+4%

8/26/10 - 6/30/11

26%

27%

+1%

6/30/11 - 10/3/11

-17%

-15%

+2%

10/3/11 - 12/21/11

13%

13%

+0%

12/21/11 - 2/29/12

10%

7%

-2%

2/29/12 - 6/27/12

-2%

-2%

+1%

9/12/08 - 6/27/12

6%

16%

+10%

Since the inception of the financial crisis, High Quality stocks have outperformed the broader market by +10%. What is notable is that high quality stocks managed to perform relatively well during both sharply rising markets as well as correcting markets. But with a standard deviation of returns at 38% over these time periods, the volatility slightly exceeds the broader market standard deviation of 35%.

LOW VOLATILITY

Low Volatility stocks have also performed notably well. To represent Low Volatility stocks, the analysis will focus on the S&P Low Volatility Index (NYSEARCA:SPLV) that represents the 100 stocks within the S&P 500 Index that have the lowest realized volatility over the past 12 months.

Date

S&P 500

Low Volatility

+/- Low Volatility

9/12/08 - 3/9/09

-46%

-35%

+11%

3/9/09 - 3/31/10

73%

48%

-25%

3/31/10 - 8/26/10

-10%

-3%

+7%

8/26/10 - 6/30/11

26%

18%

-8%

6/30/11 - 10/3/11

-17%

-7%

+10%

10/3/11 - 12/21/11

13%

11%

-2%

12/21/11 - 2/29/12

10%

2%

-8%

2/29/12 - 6/27/12

-2%

4%

+6%

9/12/08 - 6/27/12

6%

19%

+13%

Since the beginning of the financial crisis, Low Volatility stocks have outperformed the broader market by an even wider margin and have done so with less volatility with a standard deviation of returns of 24% versus the broader market at 35%. But it is also notable that while this Low Volatility category solidly outperforms the broader market during down markets, it also tends to underperform by a meaningful margin during up markets.

While each of these two categories has performed notably well versus the broader market, when left to chose between the two we are reminded of Monica's response to Coleman at the end of Trading Places over the question of the lobster or the cracked crab.

"Can't we have both?"

The answer is yes. But the next consideration is how is the dish best served for stock investors.

THE UNION OF HIGH QUALITY AND LOW VOLATILITY

One potential approach would involve a portfolio with an equal weight to High Quality and Low Volatility. The following are the blended return results of such an approach since the beginning of the financial crisis.

Date

S&P 500

HQ Union LV

+/- HQ Union LV

9/12/08 - 3/9/09

-46%

-41%

+5%

3/9/09 - 3/31/10

73%

65%

-8%

3/31/10 - 8/26/10

-10%

-5%

+6%

8/26/10 - 6/30/11

26%

22%

-4%

6/30/11 - 10/3/11

-17%

-11%

+6%

10/3/11 - 12/21/11

13%

12%

-1%

12/21/11 - 2/29/12

10%

5%

-5%

2/29/12 - 6/27/12

-2%

1%

+3%

9/12/08 - 6/27/12

6%

18%

+12%

Such an approach only provides marginal improvements over the strategies applied independently. Overall returns are higher and the standard deviation of returns lower versus High Quality only. However, the results of the combined strategy are actually somewhat worse than the Low Volatility only approach. And the differential in return both positive and negative versus the broader market is more narrowly defined. Thus, it is worthwhile to consider other methodologies where these two approaches can be combined.

THE INTERSECTION OF HIGH QUALITY AND LOW VOLATILITY

It is the subset of stocks that rank within both the High Quality AND Low Volatility universes that have provide the most differentiated and rewarding experience for stock investors since the beginning of the financial crisis. Suppose an equal weighted portfolio that consists only of those stocks that are members of the S&P High Quality Rankings Index AND the S&P Low Volatility Index. The following are the blended return results.

Date

S&P 500

HQ Int. LV

+/- HQ Int. LV

9/12/08 - 3/9/09

-46%

-33%

+15%

3/9/09 - 3/31/10

73%

54%

-29%

3/31/10 - 8/26/10

-10%

-3%

+3%

8/26/10 - 6/30/11

26%

23%

-4%

6/30/11 - 10/3/11

-17%

-6%

+9%

10/3/11 - 12/21/11

13%

12%

-2%

12/21/11 - 2/29/12

10%

4%

-3%

2/29/12 - 6/27/12

-2%

5%

+7%

9/12/08 - 6/27/12

6%

42%

+36%

The performance differential versus the broader market under this approach has been substantial from a risk-adjusted returns perspective since the beginning of the financial crisis. Total returns over this time period have been 42% with a standard deviation of returns at 25%, both of which compare most favorably to the 6% return and 35% standard deviation marks for the broader market. It should be noted that stocks under this strategy tend to outperform during down markets and underperform during up markets, the combined results over time has more than compensated investors along the way.

Thus, a portfolio that focuses on stocks with BOTH the characteristics of High Quality and Low Volatility have demonstrated the ability to meaningfully reward investors during periods of crisis. Taking this theme one step further, those investors that may be seeking to add even additional value beyond what is provided by an equal weighted universe of these High Quality and Low Volatility names can take the next step by conducting fundamental and technical analysis to select what they perceive to be the most attractive stock returns opportunities from this universe. At present, this universe consists of the following 49 stocks:

Ross Stores (NASDAQ:ROST), TJX Companies (NYSE:TJX), Target (NYSE:TGT), Yum! Brands (NYSE:YUM), Home Depot (NYSE:HD), McDonald's (NYSE:MCD), Wal-Mart (NYSE:WMT), McCormick (NYSE:MKC), PepsiCo (NYSE:PEP), CVS/Caremark (NYSE:CVS), Coca-Cola (NYSE:KO), Hormel Foods (NYSE:HRL), Colgate-Palmolive (NYSE:CL), General Mills (NYSE:GIS), Sysco (NYSE:SYY), Kellogg (NYSE:K), Procter & Gamble (NYSE:PG), Kimberly-Clark (NYSE:KMB), Clorox (NYSE:CLX), JM Smucker (NYSE:SJM), Altria (NYSE:MO), Costco (NASDAQ:COST), Kraft Foods (KFT), ConAgra (NYSE:CAG), Campbell Soup (NYSE:CPB), ExxonMobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), Abbott Laboratories (NYSE:ABT), Becton Dickinson (NYSE:BDX), Baxter International (NYSE:BAX), Northrop Grumman (NYSE:NOC), Raytheon (NYSE:RTN), Lockheed Martin (NYSE:LMT), International Business Machines (NYSE:IBM), Paychex (NASDAQ:PAYX), Automatic Data Processing (NASDAQ:ADP), Microsoft (NASDAQ:MSFT), Ecolab (NYSE:ECL), Praxair (NYSE:PX), Sherwin-Williams (NYSE:SHW), Entergy (NYSE:ETR), Wisconsin Energy (NYSE:WEC), Nextera Energy (NYSE:NEE), AGL Resources (NYSE:GAS), Sempra Energy (NYSE:SRE), FirstEnergy (NYSE:FE), Dominion Resources (NYSE:D), Southern Company (NYSE:SO), Oneok (NYSE:OKE).

So as the potential broader market risks continue to rise as we move into the second half of 2012, investors that are interested in maintaining exposures to the stock market may be best served by focusing specifically on those High Quality and Low Volatility names that have collectively demonstrated the ability throughout the crisis to perform better than the broader market at a lower level of risk.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Source: Stocks: The 2 Keys To Successfully Navigating The Crisis