By Tom Bradley

This current market rally has been characterized as ‘a dash for trash’. In other words, lower quality companies have seen their stocks bounce back dramatically, while the higher quality ones have experienced more modest gains. When the companies that were left for dead start to breathe again, their stocks double, triple or quadruple in short order. It’s a logical outcome, albeit a risky one to predict.

From reading the latest GMO Quarterly Letter written by Jeremy Grantham, it would appear that the latest dash was a record setter. The return difference over the last three months between high and low volatility stocks in the U.S. was 49%, well beyond previous cyclical rallies. Another measure of quality – low-priced versus high-priced stocks – tells the same story. On average, the ‘under $5.00 stocks’ outperformed the ‘over $50.00 stocks’ by 91%.

Obviously, there are lots of exceptions to this pattern. The Canadian banks have experienced a huge rebound and they can hardly be categorized as trash, although there were concerns that they might get caught up in a banking crisis that was much bigger than them.

Where do we go from here? Well, time will show that some of the trash went too far, while some of the moves will fairly reflect the corrective measures that were taken to address life-threatening issues (e.g. Teck was able to refinance its debt and alleviate its liquidity crunch). As for the high-quality laggards, they still look cheap. In light of our being in a more normal market again (valuation-wise), Mr. Grantham says, “Only U.S. quality feels (and measures) to us like a real outlier.”