In March this year, Credit Suisse predicted the start of a "gummy bear" rally. Colloquially, a gummy bear rally is one where the stock market increases in the 12 months following a 20 percent decline. The history of gummy bear rallies suggests that the stock market typically enjoys broad based gains in the first half of a gummy bear rally, followed by selective gains as the rally matures. This makes stock picking crucial after the easy gains are over.
So what?
Importantly for investors, the S&P/ASX 200 Index (ASX: XJO) fell into a bear market (defined as a 20 percent fall in six months) in February this year, after retreating from its highs posted in April 2015.
Today the Fairfax Press revealed new analysis from Credit Suisse stating that the gummy bear rally theory remains on track, with the share market gaining over 12% since falling into a bear market.
If history is anything to go by, then according to Credit Suisse, the bulk of easy gains are over with a further rally in shares being driven by stocks with attractive free cash generation.
Here are two stocks I believe are worth watching.
QBE Insurance Group Ltd (ASX: QBE)
Global insurer QBE reported a 9% increase to cash profit after tax in its 2015 full-year results. Although net profit after tax was down, the group managed to lift its cash return on equity to 8.3% (from 7.7% in 2014). Impressively, its cash balance at year end sat at US$662 million which it intends to use to increase the group's dividend payout ratio moving forward.
This makes QBE a stock to watch during the gummy bear rally.
Telstra Corporation Ltd (ASX: TLS)
Telstra is a utility company which benefits from scale. Given most of its costs are relatively fixed across its network, Telstra is able to generate high margins. It therefore benefits when new subscribers come onto its services. Relevantly, this high margin business bodes well for cash generation.
In its first half of 2016, Telstra increased its retail mobile services by 235,000 customers to sit at a total 16.9 million. Its fixed broadband and fixed bundle customers also grew, indicating further cash flow will be generated moving forward.
Importantly, Telstra's net cash from operations (as at 31 December 2015) was $3.7 billion, indicating very healthy cash retention of 26% on revenue of $14.2 billion. This makes it another one to watch.
Foolish takeaway
If investors are to believe Credit Suisse's prediction of the "Gummy Bear" rally, then it is likely that the easy profits are priced in. This means investors will need to look beyond recent winners like CSL Limited (ASX: CSL) and Macquarie Group Ltd (ASX: MQG) to find stocks that will provide the next leg-up to this rally.
Whilst Telstra and QBE generate healthy cash flows, if investors look hard enough they're sure to find many more companies like it; some which are even more profitable.
