Focus On Less Leveraged Companies When Markets Get Squirley

2015 is looking like one of those years in the stock market where it feels like investors have wasted a lot of time and effort for nothing. We have undoubtedly had a lot of ups and downs, both literally with stock prices and emotionally for investors, and all we have gotten in return is a market that is basically flat (intraday the S&P 500 is a whopping 48 bps higher YTD). We all know that even in a flat market, however, there are pockets of the market that have done well (i.e. growth counter-cyclicals) and that have performed poorly (hello to energy stocks and to our friendly neighbor to the north). For investors that think a more volatile market is here to stay for 2016, it may be helpful to focus their attention on companies with less leverage. This strategy paid off in 2015.

In the scatter plot below, we plot median YTD performance (y-axis) against median long-term debt (LTD) as a % of total capital. We are looking at industry groups for both emerging market and developed market companies. As you can see, companies with lower overall levels of long-term debt as a percentage of its total capital tended to have higher equity returns this year. In fact, if we look at equity returns over the past four years we see that this relationship continues to hold. We would be surprised if in 2016 if more liquid companies didn’t continue to dominate their more leveraged peers.

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