Flight to Quality Coming in Stocks? - TheStreet

Flight to Quality Coming in Stocks?

Startlingly bad economic numbers have some questioning the wisdom of beta.
Author:
Publish date:

A sharp decline in stocks recently has some analysts wondering whether now is the time to get out of speculative tech names and into quality issues that have largely been ignored this year.

Stocks that zoomed higher in the third quarter were among some of the biggest laggards on Tuesday, as investors began to question whether the economic recovery priced into these issues will actually materialize. Meanwhile, a handful of tobacco and consumer products stocks were finally getting some respect.

"We would take advantage of the recent market weakness to accumulate positions in larger capitalization, higher-quality companies, with strong cash flow and clean balance sheets that should benefit as this rally matures," said Richard Nash, chief market strategist at Victory Capital Management.

The

Nasdaq

has jumped over 10% in the third quarter after a 21% climb in the second, as investors piled into names like

PMC Sierra

(PMCS)

and

Yahoo!

(YHOO)

. Yahoo is up about about 90% since hitting a low in March and has climbed 8% for the quarter. PMC has risen 150% since it bottomed out six months ago and has climbed 12% for the quarter.

In contrast, shares of

Altria

(MO) - Get Report

fell 2% in the third quarter and

Coca Cola

(KO) - Get Report

was down 6%.

The tables were turned Tuesday, as both Coke and Altria moved higher while technology issues pulled back.

So far this year, lower-quality, lower-priced stocks that are highly volatile have outperformed the market by a wide margin. Indeed, the 50 highest beta stocks in the

S&P 500

have generated returns of almost 70% in 2003, while the 50 lowest beta stocks have returned about 10%, according to Nash.

Similarly, the 50 stocks with the lowest absolute price level have gained almost 60%, while the 50 highest-priced stocks have returned just 11%. Not surprising, nondividend payers or companies that pay a very small dividend have outperformed the rest.

Some traders complain that investors have learned few lessons from the market bubble in 1999 and 2000. Back then, investors pushed growth stocks to new heights despite questionable fundamentals. Although price-to-earnings multiples aren't as high as they once were, they're hardly reasonable. Yahoo!'s P/E is 102 based on this year's earnings, and PMC has no P/E because it is expected to lose money in 2003.

"Many investors feel compelled to go with past performance and therefore rotate into previously strong styles and strong sectors," said Jeffrey Saut, chief investment officer at Raymond James. But these sectors typically regress, leaving investors with big losses. "Past performance is often negatively correlated with future relative performance," he said.

Of course, some bulls say it's too soon to pull out of tech names, noting that the best upward earnings revisions tend to come from the information technology sector. This week, Smith Barney analyst Tobias Levkovich recommended that investors buy

Intel

(INTC) - Get Report

,

Cisco

(CSCO) - Get Report

,

Novellus

(NVLS)

and

Jabil Circuits

(JBL) - Get Report

.

Still, Levkovich acknowledged that if "exogenous shocks occur" or corporate confidence is shattered, say, from continued joblessness, optimistic earnings projections for this year and next could be revised lower. That would put a stock like Novellus -- which currently trades at a P/E of 50 based on next year's earnings -- at considerable risk.

As originally published, this story contained an error. Please see

Corrections and Clarifications.