The days of easy money are over.And with the Federal Reserve expected to hike interest rates later this month, equity investors are seeking out companies well-equipped to withstand tighter lending conditions.
In other words, they want to buy stocks with strong balance sheets – ones with easy access to liquidity and minimal debt exposure. And they’ve already started.
Shares of firms with strong balance sheets are up 11% since the start of the year, outpacing their flimsier brethren by 3.5 percentage points, according to data compiled by Goldman Sachs and Bloomberg. That’s the widest spread in 14 months for a period of that length.
The recent outperformance has helped the strong balance sheet group close the gap on its weaker peers, which have piggybacked off an unprecedented wave of debt financing to bigger gains throughout the eight-year bull market.
The accommodative lending conditions, combined with an improving economic picture, created ideal conditions for traders looking to take on the added risk of companies with less-than-stellar finances. And it paid off. The weak balance sheet group rallied 50 percent in 2013, beating the 30 percent advance in the S&P 500 that was itself the best return since 1997.
But now that the increasingly hawkish Fed has started to tighten, the days of easy gains in highly-leveraged stocks appear to be winding down. After all, higher-quality companies are better suited to absorb market shocks, and don’t experience as much volatility.
The strong balance sheet basket maintained by Goldman contains 50 companies across eight core S&P 500 industries that rank highest in measures comparing equity to total liabilities and earnings to assets, compiled in a gauge known as the Altman Z-Score.
As of an update in January, the basket contained Facebook and Alphabet, which make up half of the so-called FANG group that’s led gains in major US indices this year. The index also held such companies as Starbucks, Monster Beverage, Exxon Mobil, Bristol-Myers Squibb and 3M.