Playing It Safe

S&P is projecting slower economic and profit growth, which means back-to-basics investing

We're coming full circle. High-quality, low-risk stocks -- think basic necessities like food, health, and money -- are back in favor, in our view.

Based on our analysis of market trends, we believe we are at or near the point in the investment cycle when it makes sense to overweight non-cyclical as opposed to cyclical issues. From a quantitative point of view, we particularly favor consumer staples, health care, and, to a lesser extent, financials.

If you want to use exchange-traded funds, three options are Select Sector SPDR-Consumer Staples (XLP), Select Sector SPDR-Health Care (XLV), and Select Sector SPDR-Financials (XLF).

We forecast that S&P 500 earnings will gain 11% in 2006 vs. 13% in 2005 and 24% in 2004. As we see it, a combination of slowing corporate earnings growth and higher interest rates (with both short-term and long-term yields now rising) will prompt investors to migrate toward less risky assets.

What's more, we note that the Chicago Board Options Exchange volatility index is at lows not seen since 1994-1995, and that February, 1995, marked the beginning of a cycle of high Quality Ranking outperformance that lasted nearly five years. Richard Tortoriello and Massimo Santicchia of Standard & Poor's quantitative equity research team believe we could now be on the verge of another period of outperformance for stocks with high Quality Ranking scores.

We recommend stocks that have the highest scores in both our STARS (STock Appreciation Ranking System) and Quality Ranking systems.

Before it's here, it's on the Bloomberg Terminal.