Home>Video>Dividends and Value Shine in Rocky First Quarter

Dividends and Value Shine in Rocky First Quarter

Tue, 12 Apr 2016

More-stable strategies outperformed more-speculative ones during the volatile start to 2016, says Morningstar's Alec Lucas.

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Video Transcript

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The S&P 500 ended roughly flat in the first quarter of 2016, but the sailing was far from smooth. Joining me to provide a recap of some of the performance trends among domestic-equity mutual funds is Alec Lucas. He's an analyst and part of Morningstar's manager research group. Alec, thank you so much for being here.

Alec Lucas: Thanks for having me.

Benz: Let's talk about the first quarter. It was, in a lot of ways, a tale of two markets. You had this massive volatility in January and the early part of February, and then a recovery. So let's talk about when you sort of look at market fundamentals and look at the economic factors that maybe were playing a role in market performance. What was going on there?

Lucas: Yeah, the first quarter was really a tale of two halves. The S&P 500, if you take that as a proxy for the market, lost about 10% between the beginning of the year and February 11. And then it shot back up from there and gained about 13%. So by the end of the quarter, you had recouped your losses and a bit more than that. And in terms of what drove it, there were concerns from the end of 2015 that essentially bled over into the present year. The Fed, as long talked about, raised interest rates by 25 basis points, or 0.25%, in December, and that signaled a vote of confidence in the economy and the U.S. recovery. 

The market, though, reacted with considerable volatility and concerns about slowing growth overseas in Europe, developing countries, especially in China. We saw the price of oil continue to plummet, and it reached a low, over a decade low, on February 11, of $26.21, that was the price of the one barrel of West Texas Intermediate Crude Oil. And then there was some talk, there were some reports about cutting production, and that served to cause a rebound in the price of oil, and the market followed suit. And so, from that bottom on February 11, it really shot back up. Concerns about global growth have stabilized, and the Fed, of course, meanwhile, began to signal that its path of interest-rate increases would be slower than the market originally anticipated. So that led to a V-shaped quarter, if you will.

Benz: So when you look at domestic-equity fund categories, not everything performed in line with one another, so you saw strong performance among large-cap stocks relative to small, and then value prevailed at the expense of growth. And I don't know if you want to take these one by one, or do you think it's part of a, sort of a general theme that investors maybe are feeling like, well, we're in the late stage of this recovery, that maybe we do want to embrace some of the more stable sorts of companies.

Lucas: Yeah, in general value stocks, outperformed growth stocks interestingly enough from a Morningstar Category perspective, the best performer was mid-cap value, whereas smaller-cap value stocks really took it on the chin in 2015. And you saw funds with weightings in dividend-oriented sectors do well. Yield-oriented funds did especially well. And those that had been in the more-speculative growth names with, say, big positions in Amazon tended to do not as well.

Benz: OK. So let's talk about some of those maybe high-quality dividend-focused funds that performed well. I know that some of them are on your coverage list. Let's talk about names that had an exceptionally good quarter, maybe syncing up with this quality-conscious, dividend-focused theme.

Lucas: Yeah, two Vanguard funds stand out: Vanguard Dividend Growth, which has been a consistent and reliable performer in down markets, had a good quarter. So did Vanguard Equity Income, and Invesco Diversified Dividend also did very well. Meggan Walsh leads that fund and has done very well in down markets, in leading that strategy. In terms of funds that didn't do so well, Fidelity Low-Priced Stock didn't do as well, Fidelity Blue Chip Growth, and of course, Sequoia has been in the news quite a bit; you've written about that. They continued to suffer from their large stake and Valeant that led to the resignation of longtime manager, Bob Goldfarb, towards the end of the quarter. We still believe in that fund...

Benz: Still a Bronze, I saw.

Lucas: It's still a Bronze, and it still has a very good 15-year track record. But it is an indication that when you have that much of your fund's assets in one name, that can lead to either big gains or, in this case, big losses.

Benz: Right. One thing that I know you keep an eye on as someone who covers a lot of active funds is the performance of the S&P 500 index products. Investors have certainly been voting with their feet in that respect, that they've been sending a lot of money to the total market or S&P 500 index funds. We don't need to touch on flows, but let's talk about performance in the first quarter. The S&P 500 had another pretty good quarter relative to the active fund universe.

Lucas: Yeah. The S&P had positive gains. I think it gained 1.35%, and a lot of funds struggled to generate positive gains. I think the promise of active management is that you lose less than the market in downturns, but that's not to say that the average actively managed fund is going to do that. The best ones do, and some of the ones I've referenced earlier did that; they managed to lose less than the market as defined by the S&P 500. But the average actively managed fund does not necessarily mean it's a good actively managed fund. And that's where investors have to be selective, and that's why we do the Morningstar Medalist Ratings.

Benz: Right. Last thing I want to touch on, Alec, is the sector view, and one sector that was really in the spotlight in the first quarter was the healthcare sector. It had logged some great gains in years prior, but gave up a lot of gains during the first quarter. What was going on there, and what drove the downward trend in that sector?

Lucas: Well, healthcare, driven by biotech and pharmaceutical stocks, has had a tremendous runup. And so, you've seen pretty high P/Es. Not as high as in the past, but at the beginning of the year, the Nasdaq Biotechnology index had a trailing 12-month P/E in the range of 23, versus 19 for the S&P 500. So it was considerably more richly valued than the broader market. And then you add to that a downturn in equities, plus concerns over limiting drug prices and regulation related to the presidential race, and that was a recipe for a severe downturn; it lost over 20%. So in essence, biotech stocks had their own bear market in the first quarter.

Benz: Do you think that that was responsible--you mentioned that there was some weakness in mid- and small-cap growth stocks and funds. Was the healthcare sector, maybe specifically biotech, potentially responsible for some of that downward trend?

Lucas: Yeah, I think it drove that, and of course, biotech stocks can be very binary. Their drug either gets approved or doesn't, and if it doesn't, they take it on the chin.

Benz: OK. At the opposite end of the spectrum, in terms of sectors that performed well, let's talk about some of those.

Lucas: Yeah. Yield-play sectors, if you will, continue to do very well. Utilities did well, telecom stocks and consumer staples, those three led the way.

Benz: And why was that? Is it just that investors continue to have an appetite for yield, given how low bond yields are?

Lucas: I think, couple factors: One would be, those are defensive sectors traditionally. So, investors fled to safety, in general, I think. And then also, yes, the Fed signaling that it would be slow in raising interest rates. Well, relative to low interest rates that you can get in fixed income, those sectors have pretty attractive returns from a yield perspective.

Benz: OK, Alec. Thank you so much for being here to share your insights. It was an OK quarter, but it didn't feel so good while it was happening. Thank you for being here.

Lucas: We survived, yeah. Thanks so much.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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