Jason Stipp: I'm Jason Stipp for Morningstar and welcome to a special quarter-end edition of the Friday Five. We're going to look at some winners, losers, and trends over the last quarter.
Morningstar markets editor Jeremy Glaser is on vacation this week. We won't hold that against him because we have John Coumarianos, senior mutual fund analyst with Morningstar, joining us today. John, thanks so much for being here.
Coumarianos: Thanks Jason. Great to be here. I know I have big shoes to fill, but I'll do my best.
Stipp: I'm sure you'll do great. So we're going to look back at a few different trends in the market. Let's start broadly and look back at some broad market trends and see who's coming out winners, who's coming out losers recently in the market.
Coumarianos: Sure. Well, the big trend is that stocks are up again, so we've had really an uninterrupted year from March 9, 2009, up through late March 2010, now where the market has done basically nothing but go up.
For the quarter, the Morningstar US Market Index is up almost 6%: 5.8%. The trend we see underneath that is that it really looks like the beginning part of this decade, where small-cap has outperformed large-cap and value has outperformed growth.
So, for example, although the market itself is up 5.8%, the small value, the Morningstar Small-Cap Value Index is up 12.4% for the quarter. Really just a tremendous return. While the Morningstar Large-Cap Index is up a mere 4.5%. Not too shabby, but when you compare it to that Small-Cap Value Index, it looks low.
Stipp: So certainly you see some of those trends playing out again. Moving down a little bit to the sector level, there are some interesting stories there, and one of them has been health care. It's obviously been in the news a lot. What's going on with health care?
Coumarianos: If you look at Morningstar's market valuation graph, you'll see that stocks overal, look a little bit overvalued. I think it is at 5% overvalued right now. But when you run down the list of stocks in 5-star territory, I think there is about 28 of them, and a very large percentage of them are health care stocks.
Stocks like Abbott Labs, Novartis, Pfizer; and then even some of the insurers: WellPoint, United Health; device maker Stryker; and biotech company Genzyme. So an awful lot of health-care stocks Morningstar analysts certainly think are cheap now.
Stipp: So certainly, some of that overhang coming off could be a nice boost for some these stocks, and probably was part of the reason keeping them down.
Coumarianos: That's exactly right.
Stipp: So moving along to bonds then, it's interesting with bonds. It seems like there's a little bit of a disparity of performance to high yield, especially, I know that a lot of people have been searching for yield. What are some of the trends you've seen there?
Coumarianos: The trends we've seen are that bonds have done just absolutely, extremely well. Actually, we're a little bit worried about that. For the quarter, the Morningstar Intermediate Bond Index is up about 2 percentage points. Corporates have done slightly better than governments, although both categories are up. High yield, the Merrill Lynch High Yield Master II Index was up about 4.4%, continuing its run for about the last year as well.
And we'd really like to cautious investors. We think a lot of investors are chasing yield now. And spreads, for example, between high-yield bonds and the 10-year Treasury are at about 6%. That is not historically a very large spread, which perhaps indicates that you are not being paid a lot to take the risk of owning high-yield bonds, or even corporate bonds right now.
Stipp: So running after that yield you could end up with a lot riskier portfolio than maybe you had intended.
Coumarianos: That's exactly right. The yield might initially look attractive, but you could face all kinds of problems if defaults continue, if the economy remains weak, and also if interest rates go up. High yields will protect you a little bit more, but investors certainly need to be careful.
Stipp: So the fourth point is actually somewhat related to bonds. We've seen a lot of money going into bonds and some money leaving stock funds, so investors certainly are going in there. What are some fund flow data that you have seen recently, and what do you take away from that?
Coumarianos: Well, the fund flow data that we've seen is that, again, bonds have received a tremendous amount of money. Stocks have gone up, and stock funds have received some money, but not nearly as much as bonds. And then, of course, a lot of money is still sitting on the sidelines in money market funds. Those are basically the trends we see.
Stipp: So if money is flowing in so much to bond funds, the stock market seems to be going up. Who's buying stocks?
Coumarianos: Hard to tell. You know, I think it's probably pensions reallocating at the end of '08 after the market tanked so badly at the beginning of '09. I suspect it's pensions and larger institutions reallocating money to stock funds to get their allocations back in order. That's our best guess, anyway.
Stipp: It's certainly an interesting one to watch. Last question for you. It seems like over the last few years, especially with the rise in ETFs, passive investing has been kind of coming out as a winner here. A lot of money seems to be going into indexing strategies. And some active managers got burned pretty badly in the downturn.
What's your take on the winner and the loser in the active versus passive argument, and how do you think that's playing out? Are investors leaving active and going to passive for good?
Coumarianos: You know, this is the age-old debate, whether you should be in a mutual fund that is actively managed or in a passive indexed fund. I never tell investors that indexing is a bad idea. I think if you're a devoted indexer, I think it's a perfectly reasonable solution to the allocation question or problem, or the "what you should do with your money" problem.
However, everyone at Morningstar knows I'm a big devotee of Benjamin Graham and value investing, and I think the most talented value investors do tend to add value over time.
In fact, the studies done by the University of Chicago professors who began their careers as efficient market proponents discovered that, historically, low price to book stocks, small-cap stocks, under-followed stocks all did incrementally better over time. They added two percentage points, in some cases, over time, and they, I think in a way to save the efficient market hypothesis, said, "Well there must be more risk there if it's doing better." I'm not so sure they proved that. I'm not so sure if you buy a low-priced to book stock you are actually taking more risk.
So some of my favorite investors in mutual funds are Charlie Dreifus' Royce Special Equity Fund, David Winters' Wintergreen Fund, David Herro's international funds at Oakmark, and of course, Steve Romick at FPA Crescent who runs a rather odd fund in that he will buy all kinds of securities throughout the capital structure of a company. So he will buy stocks, bonds, and even hold some cash at times.
And it is interesting to note that a lot of value investors...Although, as a broad trend in the industry, cash and mutual funds looks a little bit low. But when you look at some of these value investors, the cash is creeping up. So Charlie Dreifus has nearly 20% cash in his portfolio. Steve Romick I believe, the last time I looked, was at 35% or 40% cash. Winters has some cash.
All the value guys are having experience in some cash creep. Mike Winer at Third Avenue Value Real Estate is about 15% cash now. Real estate is another category that has had a tremendous run in '09 after its staggering losses in '08. And it looks like Winer is playing it a little bit safe now.
One last thing I want to note, is that even as a growth family, the Buffalo Funds that we're very fond of, and you can start to see close to 10% cash in some of their funds, too. They are growth investors, but they are very valuation conscious. They are very concerned about the price they pay for securities. And if you are concerned about the price you pay, you have got to be a little bit worried about how far prices have run over the last year or so.
Stipp: Sure. So some very interesting color to certainly look at where those active managers are putting their money and taking money off the table, for sure. Well thanks for weighing in on that John.
Stipp: Thanks for joining us for the Friday Five.
Coumarianos: Thanks so much.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.