Anxiety leads to sell-off--and some buying opportunities.
Fears of inflation and uncertainty regarding the sustainability of corporate profits led to a market sell-off late in the second quarter. Volatility rudely imposed itself on investors accustomed to calm after the end of the bear market in 2002. All Morningstar diversified equity indexes posted losses for the trailing 13 weeks through June 22, and the Morningstar U.S. Market Index shed 4.3% over the same period, but still managed to eke out a gain of about 1% for the year to date. Once again, smaller-cap and more value-oriented indexes are outperforming for the year, posting gains for 2006 despite second-quarter losses.
Macroeconomic questions gripped the markets, as new Federal Reserve Chairman Ben Bernanke appears poised to raise rates at least one more time as of this writing, precisely as the economy appears to be slowing. Investors fear the Fed tightening too hard, sending the economy into a recession. They also fear a return of "stagflation" from the 1970s, when rising prices (partly due to higher energy costs) and a slowdown visited the economy simultaneously.
There seemed to be no place to hide, with foreign markets also declining, the Lehman Brothers Aggregate Bond Index falling over 1%, and the Dow Jones-AIG Commodity Index dropping from nearly 190 at its peak in May to below 170 on June 22. However, large, slow-growing companies weathered the swoon rather well. The Morningstar large-cap indexes held up the best during the bloodletting of the past month, with the small-cap indexes bringing up the rear.
This didn't catch Morningstar analysts completely by surprise. First, Morningstar's director of stock analysis Pat Dorsey reported that a variety of factors pointed toward investor complacency and the inexpensiveness of high-quality stocks. Second, mutual fund analysts have been hearing from their favorite managers that high-quality large-cap stocks haven't looked this cheap in a long time. Fund analyst Gregg Wolper reported that world stock fund managers had noticed topnotch U.S. companies selling at more compelling prices than their foreign counterparts.
The domestic-foreign debate continues, however, with Warren Buffett telling shareholders of his company, Berkshire Hathaway
Surveying the Sectors
Media dragged itself up off the mat, posting a 2.4% return for the trailing 13 weeks through June 22. The worst five-year performing sector, media bounced back to the satisfaction of Morningstar analysts, who have viewed newspapers and other media enterprises as cheap for some time. Tribune
Media conglomerate Liberty Global
Software brought up the rear, dropping 10% for the trailing 13 weeks through June 22 and more than 5% for the year to date. Salesforce.com
Along with cable TV, business/online services, and mining, the hotel industry was among the best performing during the quarter, advancing about 5.5% for the trailing 13 weeks through June 22 and adding to powerful gains for the year. A shortage of hotel rooms and increased travel have driven prices and profits up for companies such as Four Seasons
While hotels enjoyed surging stocks, homebuilders suffered the hardest share price declines, with the category shedding 27% for the trailing 13 weeks through June 22. Centex
Style and Market Cap Indexes
Morningstar US Value Index: -2%
Continuing a multiyear trend, value outperformed growth for the quarter. The Morningstar US Value Index dropped 2% for the trailing 13 weeks through June 22, though it maintained a 4.6% gain for the year to date. The energy-heavy index got a boost from integrated oil company Chevron
The Morningstar US Value Index carried a heavy weighting in financials, which rose modestly for the quarter. Citigroup
Morningstar US Core Index: -4.5%
The Morningstar US Core Index dropped 4.5% for the trailing 13 weeks through June 22, though it maintained a 1.3% gain for the year. Industrial component General Electric continues to flounder, shedding 2% for the trailing three months and nearly 4% for the year to date. As mentioned above, Warren Buffett recently picked up shares of the venerable industrial, and Morningstar analysts have given it a "wide moat" designation and praise the capital-allocation abilities of its executives--an obviously crucial skill set for managers of a conglomerate.
The index's second-largest component Wal-Mart
Morningstar US Growth Index: -6.7%
Once again, the Morningstar US Growth Index lagged its core and value counterparts, shedding 6.7% for the trailing 13 weeks through June 22 and nearly 4% year to date. Besides Microsoft's extended floundering, the index's second-largest component, Johnson & Johnson
The US Growth Index remains the second-worst for the trailing three- and five-year periods (behind the Morningstar Large Growth Index). Investors will have to wait longer for growth stocks to rebound after their dismal performance during the bear market (2000-02).
John Coumarianos is a fund analyst with Morningstar. He has a position in the following securities mentioned above: Microsoft, United Parcel Service, Berkshire Hathaway, and Johnson & Johnson.
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