The US stock market is down a bit as investors are flocking to quality stocks, as reported by CNBC. What is going on? Why is there a flight to quality investments?

Both before the market’s October sell-off and in the two-week bounce, investors have shown a clear preference for “quality” stocks.

Not the same as cheap “value” stocks, these are companies with less debt, stable businesses and some defensive characteristics in a tougher market or economy.

A grouping of such companies by Citi surfaced the likes of Walmart, McDonald’s, Pfizer, Procter & Gamble, Amgen and Quest Diagnostics.

While not predictive in itself, this pattern is one seen in the run-up to a bear market.

So, what is a quality stock? CNBC notes this.

Quality has no single, strict definition. But the common traits are a sturdy business not reliant on a strong economy; high and resilient profitability; and a strong balance sheet unburdened by much debt.

The point is that many investors are hedging their investment risk as the bull market gets older and older, the trade war does not appear to be going away, and a House of Representatives controlled by Democrats may be a thorn in the side of the Trump administration.

Does a Quality Investment Need to Be a Stock?

An investment that is highly likely or even guaranteed to make a profit and is very unlikely to or guaranteed not to produce a loss should be considered a quality investment. When the risk of an economic downturn or market collapse rears its ugly head, you might just want to choose an investment that will not lose money no matter what happens. In our article we noted that bank deposits are protected by Federal Deposit Insurance. US Treasuries are protected by the credit of the US government. High grade corporate bonds are quite safe. And, long term investing in value (quality) stocks is a way to preserve capital during a downturn and a experience gains as the economy and market improve.

Why Is This Happening Now?

Every investment niche has a cycle. Gold, real estate, agricultural commodities, stocks and any others, all go up and then come down. A steadily growing economy, low interest rates, vibrant global trade, and stability in the social and political arenas lead to higher values in all of these investment niches. But, it would appear that many investors think that the cycle is running its course. As an example, the S&P 500 is up only 4% this year despite the Trump tax cuts, repatriation of billions in offshore cash, a twenty percent increase in earnings, and about a trillion in stock buybacks. What happens in the coming months when the Fed continues to raise rates and a trade war with China starts to damage US agriculture? Folks may not be leaving the stock market, but a lot of them are repositioning themselves with expectations of a different looking investment scene in the coming months and perhaps years.

Is This an Investment Sea Change or a Just a Bump in the Road?

If you are a passive investor and only put your money in index funds, you need only pay attention to the general health of the economy and the sector in which you are invested. But, if you are heavily invested in individual stocks, you need to understand how that company makes its money and how it will continue to do so into the future. Years ago Kodak was a secure investment. It had invented the personal camera and dominated the production of camera film and its processing for photos. Then digital came along and Kodak’s business plan did not work anymore.
Apple stock dropped a few percent just this morning. One of their suppliers, Lumentum, reported that a large customer was reducing orders. The “bump in the road” interpretation is that Apple is just adjusting for a slower part of their business cycle. The “sea change” interpretation is that there is not much more room for Apple to expand their market share and that technological innovation elsewhere in the tech world will start doing damage to their business plan.



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