Christine Benz: Hi, I am Christine Benz for Morningstar.com and welcome to the Friday Five. The recent market sell-off has had a few surprises for investors. Here to discuss some of them is markets editor, Jeremy Glaser.
Jeremy, thanks so much for being here.
Jeremy Glaser: It's my pleasure, Christine.
Benz: So what are we going to talk about today? What was surprising?
Glaser: I think this week we're going to take a look at Treasuries, at tradition, at dissents, at earnings, and finally at the intensity.
Benz: So let's start with Treasuries, what was surprising there? We saw the downgrade, yet Treasury prices went up; that's pretty surprising right there.
Glaser: Yeah, and I think even taking a bigger picture, Treasuries really have had an incredible run. I think that a while ago lot of people took a look at the Treasury market and looked at just how low yields were on both on short-term-dated debt and also on long-term-dated debt and said, "Really there's no way this could go any lower." And it actually has. Treasuries have had really an incredible rally despite concerns about the debt ceiling, despite the Standard & Poor's downgrade. No matter what, people continue to see Treasuries as the safe haven, and continue to see them as this great liquidity pool and places they can put their assets. People still really see them as risk-free even if S&P says that they're not.
Benz: Right, I saw the Vanguard Long Treasury fund actually was up something like 12% in this period in which stocks have sold off, so that's a tremendous runup.
Glaser: Yeah, and another thing that was a little bit surprising about Treasuries, at least the bond market in general, was that when we looked at bond funds, some of the best-performing ones were really the index funds, really the ones that hold just a ton of government debt. So, some active managers a little more focused on getting out of the Treasury market and looking at other places for yields maybe on the hopes of a recovery actually underperformed managers that really just held a bunch of Treasuries because Treasuries just did so well. And I think if we're really concerned about an economic slowdown, you really see Treasuries as that risk-free rate, and people want to get out of risk assets, it's not inconceivable that Treasuries go even lower. I talked to Jeffrey Gundlach this week; that's his view that a slow growth means even better run for Treasuries. But we'll have to see exactly how that turns out.
Benz: So let's talk about some of the traditional aspects of this sell-off, as well as some surprises that came out of it for you.
Glaser: In 2008 a lot of the rules that people had about what a recession looks like or what a sell-off looks like, really were broken. It was much steeper than people thought. There was a ton of volatility, and sectors that people traditionally thought that was very defensive like health care actually got hit pretty hard. As I think we have discussed before, people weren't buying their medicine; people were putting off elective procedures. But in this sell-off, we really saw a return to form in a lot of traditional categories and with the traditional returns that we have seen before.
So health-care stocks and consumer defensive stocks, like Procter & Gamble, actually performed relatively well. They are still off, but they did better than the market as a whole. Companies like basic materials firms and anything that was with energy, anything that has really leveraged to commodity prices, which were falling, did even worse in the market. This is what we would expect in kind of a traditional recession, a traditional downturn.
Even on the capitalization spectrum, large-cap stocks did a little bit better than mid-cap stocks, which did a little better than small-cap stocks. Again, people see larger companies as safer; they are going into less risky assets. This is something that wasn't all that surprising.
Now, one thing that maybe was a little bit surprising, that it wasn't traditional, was the emerging markets held up better than developed markets; people generally see developed markets as being less risk risky than emerging. But I think it shows in this emerging paradigm perhaps people see those markets that have growing middle classes and have relatively strong sovereign balance sheets. It's actually been less risky than investing in Europe or investing in the United States. So we will see if that's a trend that can really continue on.Read Full Transcript
Benz: And maybe emerging-markets valuations weren't quite as steep as they once were too, so that made them a little more of a place to be in a turbulent market.
Benz: So Jeremy we had the Federal Reserve release its opinion this week, and there were also some dissenters. Give us your taken on that and what was surprising now?
Glaser: Little bit of an unusual statement from the Fed. We have gotten very used to these incredibly boiler plate statements coming out of the Federal Open Market Committee, and this week we got some new language. Instead of just that rates are going to held for an extended period of time, they actually put a timeline on it, that we have about two years somewhere in the middle of 2013, that for at least that amount of time, rates are basically going to stay at exactly zero. We're going to stay with this extremely lose monetary policy.
But we also got three dissents from members of that committee, which is extremely unusual. We haven't seen that level of dissent for years, I mean for over a decade. The early 90s was last time it was there. It just shows that there is some division within the Federal Reserve about how to actually approach this problem. And it also shows if the Fed really has the tools and the ability to use those tools in order to loosen monetary policy even more and either reinflate stocks somewhat or try to keep the economy from veering back into recession. Now, I don't think this is going to be fatal for Fed chairman Ben Bernanke. The Wall Street Journal on Thursday featured interviews with some of the directors who had voted against the timeline, and they were very positive. They had very nice things to say about Bernanke.
But certainly it just shows that's it's not going to be easy to push through more quantitative easing. It's not going to be as simple as flipping a switch. The Fed's doesn't have great tools anymore. There are things they can do, but they are not going to be as effective as they once were.
Benz: Right. As one our former colleagues Michele Gambera said that they have a family of four and one blanket, which shows what their limitations are. Jeremy, let's talk about earnings. I think that what we've continued to see is that earnings have been pretty strong. Give us your perspective on that issue?
Glaser: Yeah, I think so. Now granted, these are earnings from last quarter, so we are not going to expect if we had more of a sudden slowdown in the economy that we would really see it in earnings yet. But just from looking at earnings and looking at what management is saying during conference calls, it doesn't seems like the world is ending, at least in the United States. This is in terms of consumer spending and in terms of people out there in economy, making those transactions that kind of a smooth everything and even keep us out of recession.
Even some business customers like Cisco this week had better-than-expected earnings. Its stock actually rallied for the first time in a while after that earnings report. And it just shows that businesses were out there and that they thought there that would be some slowdown from reduced government spending, some reduced corporate spending. But generally they were seeing very positive trends, and usually if you look back to 2008 and listen to the conference calls before everything really got bad you heard a lot of hedging from managements teams.
So, we saw some of that in this quarter, but not nearly as much as you would suspect for the economy to be really falling off a cliff. So, I think that earnings being still reasonably strong and for outlooks remaining reasonably strong, that is collectively probably a surprising sign given how worried the market is about the economy.
Benz: Right. I guess one worry going forward is that all this pessimism that we have been experiencing recently could begin to have a negative psychological affect on consumers, and they could start to experience that sort of negative wealth effect and really pull on their purse strings as a result.
Glaser: Yeah, exactly.
Benz: So Jeremy, finally one last surprising thing of this week was just the violence of this sell-off that we saw and just the extreme point swings that we saw from day to day or hour to hour in some cases. What's so surprising about that?
Glaser: I think it's just that the incredible intensity in it. If you would have told me two weeks ago that there would have been a day like Wednesday, where we lose over 500 points and that I would not be completely freaking out. I would have thought that you were crazy. I would say, "A 500-point loss on the Dow in a day, I mean that's going to be incredible." And the fact is that by Wednesday, we're all kind of used to it. It's like we were saying, "Oh, 500 points. That seems totally reasonable." And I think it is surprising to see those huge swings, mainly because we're not getting the whole lot of new information.
When we talk about the debt-ceiling debate, we looked at those underlying problems in on the United States' balance sheet; that's nothing new. With S&P's report, I think I had mentioned before that anyone who was surprised to find out the United States political system is at a bit at a standstill probably hasn't been paying very close attention to the United States political system during the last few years. I think certainly that with economic data reports that came out, a lot of them weren't great. I think we look at the GDP report being very weak, and manufacturing numbers not looking as strong. We had some OK jobs numbers, but nothing spectacular. There wasn't any huge red flag.
Benz: How about Europe? Do you think that is weighing on the market?
Glaser: Yeah, I think it absolutely was. But again, I think a lot of what we're seeing in Europe was not this incredibly new idea that there could be contagion from the peripheral countries. We've been talking about contagion for over a year now, I mean the only reason that anyone ever cared about Greece or ever cared about Portugal was not because their failure was going to have an impact, it was because if that started floating into countries such as Italy and counties such as Spain, you could be in trouble. Now, we did hear more about France this week than we have in a while.
Benz: That was a surprise to me.
Glaser: Yeah and I think hearing that France could lose it AAA rating and there could be some problems there certainly was somewhat unusual. But it didn't seem like it was such an incredible statement that you would see the incredible volatility that we have.
Benz: Some of it may have been rumor-mongering in terms of the banks that have been rumored to be about to go down. We've heard it now that perhaps that wasn't grounded in fact?
Glaser: Yeah and it could be. I think when we see these huge swings that kind of surprises me. So, I thought stocks are pretty much fairly valued. If the economy is slowing; I think to see a sell-off would not have been the most shocking thing in the world. You kind of expected the market to track a slowing economy. But for it to happen so violently and for it to have such big swings both up and down caught me a little bit off guard.
Benz: Well thank you, Jeremy, for sharing your insights. It's been a volatile week. I am hoping we'll calm down a little bit here in the next couple of weeks. Thank you.
Glaser: I hope so too. Thanks, Christine.
Benz: Thanks for watching. I am Christine Benz for Morningstar.