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By Christine Benz | 08-11-2011 05:32 PM

Five Surprises From the Sell-Off

Morningstar's markets editor Jeremy Glaser explores surprises in Treasuries, traditions, dissents, earnings, and intensity during the correction.

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.

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