It seems that Wall Street is always coming up with new buzzwords or phrases.

When the AI transaction actually kicks off, the most popular term is "the seven giants of U.S. stocks ( Magnificent Seven )". Subsequently, terms like " AI enablers ( AI enablers )", "sellers ( picks and shovels )", and more recently, "momentum ( momentum )" emerged.

Nowadays, as investors worry about rising interest rates, the high costs associated with the ambitions of AI, and the excessive concentration of market weight, the hottest term has become "quality ( quality )". In the context of the stock market, it refers to companies that have strong and sustainable profitability, solid balance sheets, pricing power, and cash flows.

Morgan Stanley has been emphasizing this for some time now. The bank's core argument is that the market is in the middle of a recovery cycle – an environment that is more selective and less speculative, and therefore more favorable to high-quality companies.

The advantage of high-quality stocks is that they are not necessarily traditional defensive assets. They can also include participants in AI transactions – it's just that the entry barrier is higher. Such companies can rely on the strength of their existing businesses to weather periods of weakened market sentiment.

High-quality stocks are starting to widen their lead.

High-quality stocks are not only attractive in terms of their future upside potential, but they have also indeed performed well over the past few months.

Morgan Stanley stated that since mid-August, its own high-quality index has risen by 6%, while the equally weighted S&P 500 index has fallen by 4%.

The chart below shows the same trend during the same period, but it uses GMO US Quality ETF (instead of QLTY) to replace Morgan Stanley's high-quality indicators. Although the components of the two are not exactly the same, this ETF still significantly outperformed and avoided losses.

AI can also participate in it.

One approach to high-quality trading is to sell off the more speculative sectors of AI trades (such as chip manufacturers) and instead buy into traditional defensive stocks (such as essential consumer goods).

But that would be rather boring. An more interesting approach is to selectively hold stocks related to AI. In the end, these companies can be mainly divided into two categories: (1) companies that use their existing profits and balance sheets to finance expansion; (2) companies that rely on debt and capital markets for financing.

Large-scale cloud service providers ( hyperscalers ) fall into the first category. They are able to make substantial investments without having financing issues become a matter of survival. It is for this reason that Microsoft, Alphabet, and Meta occupy three of the top four positions in QLTY.

This also makes the financial report released by Meta after today's close a timely test to assess the degree of overlap between "high quality" and "AI". Its massive expenditure plan is distinctly different from the reckless bets on data centers that rely on debt (ahem, CoreWeave, ahem). This is because Meta can fund these investments with its highly profitable advertising business.

This self-sustaining capability is increasingly becoming an important demarcation line in AI transactions. A strong balance sheet can help a company join the “high-quality club,” but it is the performance that truly allows it to remain there.

The above is the report and statement from Business Insider.