Jason Stipp: I'm Jason Stipp for Morningstar.
It's shaping up to be a bit of a cruel summer for stocks, as we've seen some volatility and some poor performance over the last four weeks. But if you are itching to take some action, Morningstar's Christine Benz, our director of personal finance, has a few tips for you first. She is joining us today.
Thanks for being here, Christine.
Christine Benz: Jason, great to be here.
Stipp: I think the first thing that we would tell investors is, yes, stocks have had some stumbles--bonds have had some stumbles in the summer as well--but you have to put things in perspective, first of all.
Benz: It's been a great year. Even though the summer has been rough, we've had domestic equities returning about 17% if you own some sort of total stock market index fund. So, even with the recent losses, investors have done all right so far this year if they have held stocks. So, I think that's one of the most important pieces of context for all of this.
Stipp: First half performance of 15%-17% is very good, but also at the same time, you might be worrying stocks are getting overheated. But they really don't look that way on a fundamental basis, at least to our analysts?
Benz: They don't. We have our price to fair value graph on the markets cover page of Morningstar.com. When you look at that today, you see stocks trading at about 1.0, right in line with their fair value. This is our total coverage universe. So, that's not a screaming buy, but nor is it reason to be terribly concerned that we're way ahead of ourselves, even though stocks are way up so far this year. So, I think that's an important piece of context.
Also, when you drill into that fair value graph and you look at the sector valuations, what you see is that there are actually potentially some pockets of opportunity. So, our analysts think that some of the cyclical stocks, which haven't performed as well year-to-date--basic materials stocks, energy stocks--actually look pretty inexpensive at this point.
Stipp: There potentially could be some opportunities out there [still].
If I am itching to do something in my portfolio, you wouldn't recommend tactically moving around and trying to get out of the way, but there are some things you can do when you crack open your [portfolio] and take a look at the underlying [holdings], just to make sure that you are where you think you are.
Benz: The baseline check you want to do is, look at your total asset class exposure, use our X-Ray tool to do that, and see how that compares to your targets. And if you don't have targets, it's time to give some thought to what your targets should be.
Once you're through that process, you can take a look at your intra-asset class exposure. It's an interesting year so far in 2013 in that we have some seen some divergences in performance across style and size factors. We've generally seen small and mid-caps outperform large-cap stocks by a good bit so far this year. So, if you haven't done anything there, you may need to move some things around and potentially move some money up into the larger-cap names, which haven't performed as well.
And you can also look at your geographic exposure, because we've generally seen U.S. stocks outperform foreign stocks so far this year. So, check your allocations there. It may turn out that you need to add to your foreign exposure.
Stipp: So even if your stock/bond allocation is within your target range, there could be some more discrete allocations in there that offer you an opportunity to rebalance.
You say it's also important to actually make sure that you really are truly diversified when you are looking at your portfolio. How can I get a handle on that?
Benz: … I would look specifically at bonds in this vein. Look at how your portfolio is exposed to the total fixed-income style box. I've been concerned for a few months now--or more than a few months--that we've seen this stampede into some of the more equity-like bond categories. We've seen huge flows to bank-loan funds. We've seen flows into high-yield bond funds. This new non-traditional bond category has been getting a lot of flows.
And my concern there is that investors, for their bonds stakes, are actually adding to the equity sensitivity [of] their portfolios, perhaps inadvertently. And so, on a day like Tuesday [Aug. 27], where we saw stocks sell off dramatically, what we saw was that some of these bond types didn't perform especially well, either.
So, at a time like this, I think it's important to remember something Jason Zweig once told me. He's the great Wall Street Journal columnist. He said, you know you're truly diversified when you've got something in your portfolio that really hurts to own. So maybe for investors that's government bonds or Treasury inflation protected securities, something that really is going to behave in the opposite way that stocks do on these down days that are inevitable if we are stock investors.
Stipp: If everything is moving up together, that also means everything could move down together, and that's really not what you want if you're looking for a diversified portfolio.
Benz: That's right.
Stipp: Christine, on a day like you said this past week, the market was moving because of macro concerns, Syria. So whether it's Syria or Europe or Japan or China, do people ever ask you, how should I invest given that China is slowing down, or how should I invest because there are issues in Syria? What should I do? What's your answer to that question?
Benz: Well, I think that it's impossible to tune out these headlines. In fact, it's important to plug into them for our [personal] lives. But in general, I think you probably shouldn't pay a lot of attention to macro headline news in regards to how you manage your portfolio. You probably do want to segregate those two activities, because generally speaking, yes, these macro issues will affect the market, but ultimately, fundamental factors and valuations will win out. So, I think that those are the key things you want to focus on rather than plugging into the headlines too much: Easy to say, hard to do.
Stipp: But in fact, sometimes macro concerns will cause great companies to sell off with everything else. So, if you are opportunistic, you actually can go in, as you were saying before, and maybe buy some things on the cheap.
Benz: That's absolutely right. I think that's why having a little bit of cash can be your friend. If you are an individual stock investor, you can potentially think about adding to some undervalued holdings after they're beaten down, or if you're not an individual stock investor, just make sure that you have a good value-oriented fund on your side, where that manager is going to be doing shopping on those days when the market is beaten down.
Stipp: We've had a bit of an uneven summer, Christine, but thanks for helping us put things in perspective.
Benz: Thank you, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.