NEW YORK, (Reuters)- The junk-stock rally lives on.
The biggest winners since the U.S. stock market got another dose of bull market fever in mid-July have been the companies with the most beaten-down shares and the ones whose business outlooks are seen as the riskiest within the Standard & Poor’s 500 Index.
This winners’ circle has been dominated by 81 S&P companies with unspectacular credit ratings of “BB” or lower, also categorized as high-yield “junk.”
The stock prices of these junk-rated companies have jumped on average by between 21 percent and 29.5 percent between July 10 and Aug. 4.
In comparison, investment-grade companies rated “BBB” or above have seen their shares rise between 9.50 percent and 19.25 percent, according to data from Bespoke Investment Group, a financial research firm based in Harrison, New York.
For example, media firm Gannett Co, which publishes USA Today, is rated “BB” by Standard & Poor’s and yet its stock has climbed 135 percent between July 10 and Aug. 4.
Further down the credit scale, Eastman Kodak debt is rated “B-“ but its stock has leaped 42.25 percent and Ford Motor Co debt is rated “CCC+” yet its stock has soared 45.10 percent during the same July-August period analyzed by Bespoke.
While the junk-stock rally is an extension of a similar move seen during the massive March rebound, some investors still argue that the rally is not sustainable without the participation of higher-quality companies.
Otherwise, it could crumble, and badly, in the face of an economic recovery that is shaping up to be anemic and bogged down by continued revenue disappointments.
But Paul Hickey, who co-founded Bespoke, said a recovery in low-quality stocks was typical when markets bounce back from heavy falls.
“There are those who will say this is a low-quality rally, but I have to say that I don’t know what people’s expectations are — a 50 percent rally in five months is anything but lousy,” Hickey said.
The S&P 500 has climbed nearly 50 percent from its 12-year closing low in early March.
In a recession and a falling stock market, companies with lower credit ratings and more leverage get punished the most. So when things improve, their stocks have the most room to run higher, Hickey explained. Conversely, the strongest companies with higher credit ratings tend to weather bad times better so when the economy improves, their stocks usually don’t skyrocket.
Jeff Shacket, vice president of corporate services at Thomson Reuters, added: “It seems to me that if investors are willing to put more money into companies with shaky finances, that’s a good sign — not a bad one.”
The healing of credit markets has much to do with the upward direction in U.S. stocks. The credit markets that Corporate America rely on as their lifeblood show signs of dramatic improvement.
The cost of borrowing for lower-rated companies has dropped below 900 basis points over comparable Treasuries — its lowest level since the Friday before the Lehman Brothers’ bankruptcy. The cost of borrowing for lower-rated firms pre-Lehman was 854 basis points.
Banks and financial firms have been huge beneficiaries of the credit phenomenon: The stock of American International Group Inc, whose debt is rated “A-“ by Standard & Poor’s, shot up 15.16 percent between July 10 and Aug. 4. It had a good day on Wednesday, too: The insurance giant, which has been bailed out by government money, saw its stock leap 62.72 percent.
INVESTORS IN LESS DEFENSIVE MOOD
Ted Baszler, vice president and co-portfolio manager at Heartland Funds in Milwaukee, Wisconsin, said he isn’t surprised that investors are in a less defensive mood.
“If you go back to the fourth quarter of 2008, the stocks that were hurt the most were the ones with too much leverage and there were issues on whether or not they could get their debt refinanced.”
But the easing in the credit market has really helped companies with higher leverage and weaker balance sheets, he added.
It should be small wonder, then, that old reliables such as Wal-Mart Stores and Coca-Cola Co — with credit ratings of “AA” and “A+” respectively — have done little during the recent rally. Wal-Mart’s stock rose only 4.79 percent between July 10 and Aug. 4, while Coca-Cola’s stock gained a measly 2.46 percent for the same period.
“Investors are probably getting out of these bastions of safety, like the Wal-Marts of the world, and moving into things with more leverage, more risk,” Hickey said. “Investors are now believing that those companies will give you more bang for the buck as we see the economy improve.”
