BMO Canadian ETF Dashboard

— as of October 31, 2018 —

Ease the Tension with Quality

Brian G. Belski

Ease the Tension with Quality

Summary of Trade Ideas

BMO MSCI USA High Quality Index ETF (Ticker: ZUQ)

A preference toward higher-quality stocks has been one of our overriding investment themes for many years. Our work suggests that these stocks perform very well over longer periods and are particularly well suited for the market environment we expect to unfold in the coming quarters. Indeed, our work shows that higher-quality stocks can help investors combat periods of increased volatility, while also allowing for participation in the upside during periods of market strength. 

In fact, our works shows: 

1.  Quality Can Help Guard Against Volatility, but Also Benefits During Periods of Market Strength 

Although we continue to be bullish on the outlook for U.S. stocks, we do believe that investors will be forced to contend with higher levels of volatility in the coming quarters. As such, we decided to highlight quality strategies, which tend to perform well during these types of periods, according to our work. 

Aug-2018-Belski-High-Quality-Can-Combat-lg.jpg#asset:1528


2.  
Quality Performs Well in Range-Bound Markets

Performance of High-Quality Screen for Range-Bound S&P 500 Periods Beginning 1990
S&P 500 Range-Bound Period as Identified by the High-Quality Screen 

Start End Duration (Days) Period Return
4/4/1991 12/11/1991 251 7.6%
1/2/1992 11/17/1992 320 4.2%
12/18/1992 7/6/1993 200 1.3%
7/16/1997 1/9/1998 177 11.6%
3/18/1999 10/8/1999 204 -7.6%
11/18/1999 10/5/2000 322 12.8%
10/11/2001 5/16/2002 217 26.5%
12/23/2003 10/25/2004 307 3.1%
11/12/2004 10/27/2005 349 -3.6%
11/25/2005 7/3/2006 220 7.3%
4/25/2007 12/26/2007 245 0.1%
1/18/2011 7/29/2011 192 4.6%
3/15/2012 12/28/2012 288 3.3%
2/18/2015 8/17/2015 180 -0.2%
11/3/2015 11/4/2016 367 2.0%
Average 4.9%

Source: BMO Capital Markets Investment Strategy Group, FactSet, IBES.


3.  High Quality Represents a Diverse Strategy

Despite common perceptions, high quality is not necessarily associated with defensive strategies. In fact, our current quality screen actually represents a pretty cyclically diverse strategy, as shown in the sector composition pie chart below. While Health Care certainly makes up a sizeable portion of high quality currently, the traditional defensive areas of the market have fairly low exposure, with Telecom, Real Estate, and Utilities entirely absent from the screen.

Fundamental Backdrop Favours Quality 

Given the type of market environment we expect to unfold, we believe our quality strategy will outperform the broader market over the next 12–18 months. This is especially true given the solid fundamental backdrop of these stocks.

Quality Exhibits Attractive Fundamentals

Metric High-Quality S&P 500
ROE 21.2 14.9
Cash as % of Market Cap 9.4 5.0
EPS Growth Volatility 8.6 15.1
NTM EPS Growth 14.4 14.3

Source: BMO Capital Markets Investment Strategy Group, FactSet, IBES.


4.  Trade Idea: BMO MSCI USA High Quality Index ETF (ZUQ)

  • Since ZUQ’s inception, it has had strong tracking with our U.S. High-Quality Screen, which we used in the analysis (see NOTE below)
  • Focus on blue-chip companies with high Return on Equity (ROE), low leverage (Debt/Equity) and stable earnings growth
  • Rebalanced semi-annually to ensure continued adherence to the quality exposure
  • An attractive way to obtain exposure to equity growth in the U.S. market, while maintaining a measure of defensiveness relative to the broad market by focusing on companies with higher profitability and stronger balance sheets


For more information, please see our most recent publication, “Ease the Tension with Quality.”.


NOTE: The above analysis is not based on ZUQ, but on our BMO Capital Markets Investment Strategy Groups High- Quality Screen: B+ or higher S&P stock rank; BBB- or higher S&P LT debt rating; 5-year EPS growth volatility lower than S&P 500 median value; ROE higher than S&P 500 median value; and cash as a percentage of market cap higher than S&P 500 median value.

Brian G. Belski

Ease the Tension with Quality

Summary of Trade Ideas

BMO MSCI USA High Quality Index ETF (Ticker: ZUQ)

A preference toward higher-quality stocks has been one of our overriding investment themes for many years. Our work suggests that these stocks perform very well over longer periods and are particularly well suited for the market environment we expect to unfold in the coming quarters. Indeed, our work shows that higher-quality stocks can help investors combat periods of increased volatility, while also allowing for participation in the upside during periods of market strength. 

In fact, our works shows: 

1.  Quality Can Help Guard Against Volatility, but Also Benefits During Periods of Market Strength 

Although we continue to be bullish on the outlook for U.S. stocks, we do believe that investors will be forced to contend with higher levels of volatility in the coming quarters. As such, we decided to highlight quality strategies, which tend to perform well during these types of periods, according to our work. 

Aug-2018-Belski-High-Quality-Can-Combat-lg.jpg#asset:1528


2.  
Quality Performs Well in Range-Bound Markets

Performance of High-Quality Screen for Range-Bound S&P 500 Periods Beginning 1990
S&P 500 Range-Bound Period as Identified by the High-Quality Screen 

Start End Duration (Days) Period Return
4/4/1991 12/11/1991 251 7.6%
1/2/1992 11/17/1992 320 4.2%
12/18/1992 7/6/1993 200 1.3%
7/16/1997 1/9/1998 177 11.6%
3/18/1999 10/8/1999 204 -7.6%
11/18/1999 10/5/2000 322 12.8%
10/11/2001 5/16/2002 217 26.5%
12/23/2003 10/25/2004 307 3.1%
11/12/2004 10/27/2005 349 -3.6%
11/25/2005 7/3/2006 220 7.3%
4/25/2007 12/26/2007 245 0.1%
1/18/2011 7/29/2011 192 4.6%
3/15/2012 12/28/2012 288 3.3%
2/18/2015 8/17/2015 180 -0.2%
11/3/2015 11/4/2016 367 2.0%
Average 4.9%

Source: BMO Capital Markets Investment Strategy Group, FactSet, IBES.


3.  High Quality Represents a Diverse Strategy

Despite common perceptions, high quality is not necessarily associated with defensive strategies. In fact, our current quality screen actually represents a pretty cyclically diverse strategy, as shown in the sector composition pie chart below. While Health Care certainly makes up a sizeable portion of high quality currently, the traditional defensive areas of the market have fairly low exposure, with Telecom, Real Estate, and Utilities entirely absent from the screen.

Fundamental Backdrop Favours Quality 

Given the type of market environment we expect to unfold, we believe our quality strategy will outperform the broader market over the next 12–18 months. This is especially true given the solid fundamental backdrop of these stocks.

Quality Exhibits Attractive Fundamentals

Metric High-Quality S&P 500
ROE 21.2 14.9
Cash as % of Market Cap 9.4 5.0
EPS Growth Volatility 8.6 15.1
NTM EPS Growth 14.4 14.3

Source: BMO Capital Markets Investment Strategy Group, FactSet, IBES.


4.  Trade Idea: BMO MSCI USA High Quality Index ETF (ZUQ)

  • Since ZUQ’s inception, it has had strong tracking with our U.S. High-Quality Screen, which we used in the analysis (see NOTE below)
  • Focus on blue-chip companies with high Return on Equity (ROE), low leverage (Debt/Equity) and stable earnings growth
  • Rebalanced semi-annually to ensure continued adherence to the quality exposure
  • An attractive way to obtain exposure to equity growth in the U.S. market, while maintaining a measure of defensiveness relative to the broad market by focusing on companies with higher profitability and stronger balance sheets


For more information, please see our most recent publication, “Ease the Tension with Quality.”.


NOTE: The above analysis is not based on ZUQ, but on our BMO Capital Markets Investment Strategy Groups High- Quality Screen: B+ or higher S&P stock rank; BBB- or higher S&P LT debt rating; 5-year EPS growth volatility lower than S&P 500 median value; ROE higher than S&P 500 median value; and cash as a percentage of market cap higher than S&P 500 median value.