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Five Years Later

The investment landscape after Lehman's Collapse.

John Rekenthaler, 09/17/2013

Lessons of the Half Decade
I won't join my fellow pundits in drawing economic, regulatory, and political lessons from Lehman's September 2008 bankruptcy. It may be that the Volcker Rule is sensible; that Fannie Mae and Freddie Mac should be dismantled; and that the Federal Reserve's post-recession response has been appropriate. Or the reverse. It is not for me to know.

Also, sacrilege as it might be to write, those topics aren't particularly relevant for an investment column. As Bill Gross demonstrated with his 2009 prediction of the "New Normal," which was spectacularly correct in forecasting the sluggish economic future and spectacularly wrong in arguing against buying stocks on the current dip, there's not much connection between economics and investments. Fidelity Magellan's FMAGX Peter Lynch has it right when he said that 15 minutes spent per year thinking about economics was 10 minutes too much.

There are some post-crash investment outcomes to be mentioned, though--the triumph of Bogle being one. Jack Bogle entered 2008 as the mutual fund industry's leading figure. Five years later, his position is that much stronger. The failure of active U.S. stock-fund managers to outperform the plummeting stock market removed their last claim to credibility, yielding to Bogle a runaway victory on the debate of active versus passive management. The company that Bogle founded, Vanguard, surged in sales. (Although ironically, much of Vanguard's success came from exchanged-traded funds, which Bogle has consistently distrusted.) Finally, Bogle's buy-and-hold mind-set paid off as stocks rebounded. The Bogle legacy, admittedly never much in doubt, has now been truly cemented.

The general precept of buying on a strong decline also remained intact. In the past half century, stocks (as represented by the S&P 500) have on four instances dropped at least 35% from their peak. At all four times, 1974, 1987, 2002, and 2008, the market fared no worse than treading water for a few months once it reached the 35% mark, and in all four cases when it began to rise again it surged strongly. It would be numerology to suggest that 35% is the magic figure. However, the next time stocks plunge and the headlines are dire, it might be prudent to draw a deep breath when the decline reaches that level and wonder if, perhaps, just perhaps, things might be better than they seem.

(The four crashes were less consistent with their economic forecasts. The 1973-74 and 2008 declines did indeed presage general unpleasantness, respectively stagflation and today's stubbornly high unemployment rate. The 2000-02 slide also coincided with a recession, although in that case stocks weren't much of a leading indicator, as by 2002 stocks were still slipping while the economy was recovering. And 1987 meant absolutely nothing economically. Except for me. My previous employer panicked, expecting a recession that never arrived, and laid off his newest employees. Two months later, I found another job, working at an investment-research start-up called Morningstar.)

Bonds also fared well. With inflation remaining low and credit quality not being of much concern, bonds of all flavors profited: long bonds, intermediate bonds, government bonds, housing bonds, corporate bonds, high-yield bonds. It has been fashionable to talk of a bond bubble and to cluck at mutual fund investors who poured into bond funds while disdaining stocks, but it's not as if bond buyers were hurt in absolute terms. In that, this post-crash period differed dramatically from the 1973-74 aftermath, wherein bondholders got smacked.

Finally, the notion of "risk on, risk off" has taken a hit. Five years back, most believed that emerging-markets stocks were driven by global investment waves. When central banks were free, asset prices were rising, and optimism in the air, the "risk on" trade occurred, and emerging-markets stocks as risky assets would soar. The reverse would happen when investors were fearful; emerging-markets stocks would fall the furthest. That pattern played out in 2008 and 2009, when emerging-markets prices created a sharp "V." Since then, though, the sector has languished even as developed-market stocks have surged. The risk trade has been on--but emerging markets have been off.

The (Lack of) Power of Positive Thinking
Jason Zweig concludes this morning's column in his usual skeptical fashion, citing a biologist who wrote, "The intensity of the conviction that a hypothesis is true has no bearing on whether it is true or not."

This, of course, applies to the science of investing as well.  A case in point is FPA New Income's FPNIX Bob Rodriquez. There's no better advocate than Bob. He writes well, he speaks well, and he has clear, strong viewpoints. When Rodriquez speaks on a matter, he gives the overwhelming impression that he has the issue completely solved, and those on the other side are hopelessly dazed and confused. He has, however, been wrong with conviction with his post-2008 investment analysis (as with Gross, better on the economics). As a result, his fund languishes at the bottom of its category for both the five- and 10-year periods.

The news is not all bad. FPA New Income was terrific for the previous 20 years. (Yes, Rodriguez has been at the company a full 30 years.) Rodriguez's stock fund, FPA Capital FPPTX, has fared pretty well in recent years. In addition, Morningstar analysts remain optimistic about FPA New Income's future, assigning the fund a rating of Silver, the second-highest on their 5-point scale. There are reasons for optimism. Rodriquez's self-belief, though, is not one of them.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.


is vice president of research for Morningstar.

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