This time, the cream isn't rising to the top.
The historic rally that has lifted the Standard & Poor's 500 Index ($INX) by 50% from its March lows has been led by economically sensitive and lower-quality stocks, including such sectors as financials, basic materials, retailers and industrials. By contrast, high-quality stocks like Abbott Laboratories (ABT, news, msgs), Exxon Mobil (XOM, news, msgs) and Procter & Gamble (PG, news, msgs) generally have lagged, with many showing outright losses this year.
The rush by investors for cyclical, economically sensitive stocks has only increased as the outlook for the global economy has brightened. But now a shift may be at hand. Quality stocks soon could start to shine.
Several factors are working in their favor, including relatively low price-to-earnings multiples, decent growth outlooks and strong financial positions. The run in economically sensitive stocks has left many of them trading at very high P/E ratios for 2009 and even 2010 -- to the extent they have any profits at all this year. Investors now can grab best-in-class companies such as Berkshire Hathaway (BRK.A, news, msgs), Microsoft (MSFT, news, msgs) and Wal-Mart Stores (WMT, news, msgs) at attractive prices and for little or no premium relative to their lesser brethren. (Microsoft publishes MSN Money.)
Jeremy Grantham of GMO, a Boston investment-management company that evaluates a range of domestic and overseas asset classes, argues that U.S. blue-chip stocks now represent some of the best investments in the world.
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Barron's has picked a dozen quality stocks that look ready to rally. The stocks trade for an average of 12 times projected 2010 earnings, excluding Berkshire Hathaway, which tends to get valued based on its book value rather than reported profits.
Each of our dozen could rise 20% in the next year, and most have secure dividends of 2% or more. The major market indexes may rise more grudgingly in the months ahead, following the biggest rally since the late 1930s. The S&P 500 Index now is valued at about 15 times projected 2010 operating profits, a premium to most of the blue chips on our list. And if the economy unexpectedly weakens, quality stocks are apt to offer greater downside protection than most of the market averages.
The bull case for the cyclicals, including many financials, rests on hoped-for 2011 or 2012 profits, but those might not materialize if the economy sputters. The investment outlook for Caterpillar (CAT, news, msgs), Ford Motor (F, news, msgs), Dow Chemical (DOW, news, msgs), Paccar (PCAR, news, msgs) and a range of other economically sensitive stocks hinges on distant earnings. New investor favorite Ford, whose shares have more than tripled this year to $8, isn't expected to earn much money until 2011. And who knows what the economy and global auto market will look like then?
"The easy winner of the cheapest-equity subcategory is still high-quality U.S. blue chips," Grantham wrote in a recent market commentary. "They were really trashed on a relative basis by the second-quarter rally in junk. I understand a rally in junk after the record decline, but this was excessive and based apparently on unrealistic hopes for a strong, sustained economic recovery."
In fact, it's one of the biggest issues confronting professional investors: Should one stick with the stocks that have been doing best -- the cyclicals -- in the hope that the rally continues or start buying quality issues?
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Your market shopping listHere's another look at blue-chip stocks to buy for the long term.
Numerous measures illustrate the outperformance of economically sensitive and lower-quality stocks. The Morgan Stanley index of cyclical stocks is up 48.6% this year, led by Ford, Goodyear Tire (GT, news, msgs), Freeport-McMoRan Copper and Gold (FCX, news, msgs), Sears (SHLD, news, msgs) and Ingersoll-Rand (IR, news, msgs). The Morgan Stanley Consumer Index, by contrast, is up 7.5%, held back by double-digit percentage declines in Safeway (SWY, news, msgs), Abbott Labs and Procter & Gamble.
Given its high-quality composition, the Dow Jones Industrial Average ($INDU) is one of the worst-performing U.S. market indexes this year: It has gained just 6% while the S&P 500 has risen 11%, the technology-heavy Nasdaq Composite Index ($COMPX) 27% and the S&P 400 Midcap Index ($MID.X) 21%. The energy sector has badly lagged the big gain in oil prices, as Dow components Chevron (CVX, news, msgs) and Exxon actually are in the red.
Continued: A dozen stocks to consider
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