Skip to Content
Fund Spy

Making Sense of an Incredible Rally

The past 12 months have provided a ride to remember--and to forget.

Exactly one year ago, it seemed that the end of the world had arrived. March 9, 2009, was the low point for the mind-rattling crash of the U.S. stock market.

Although problems and uncertainties still abound, at least the financial system doesn't seem to be hovering on the verge of collapse, as it did one year ago. And there have been signs of revival--however meager and halfhearted--in the economy, in corporate results, and in the job market. That's been enough to propel stock markets to superb gains over the past 12 months.

It's impossible to know where the market is headed from here. But crossing the March 2010 threshold has revealed some important lessons for investors--a few of which are not obvious.

For Entertainment Purposes Only
A look at the one-year returns for all of Morningstar's fund categories shows how incredibly strong, and also remarkably broad, the rally has been. The category returns should make one realize how unlikely it is that such performance will recur on more than the rarest occasions.

The most notable outperformers have been the categories typically associated with higher levels of risk. For example, diversified emerging-markets funds have gained more than 100% on average since the March 2009 lows. Some have climbed substantially higher. Templeton Emerging Markets Small Cap (TEMMX), which is near the top, has returned more than 170%. Another area known for its volatility--high-yield bond funds--also has produced astounding returns. The funds in that category have gained more than 50% on average over the past year, and many have soared much higher.

But the most adventurous areas weren't the only ones with jaw-dropping returns. The large-blend category average is up about 70% in this remarkable stretch, and the small-value group has zoomed more than 100%. Even the intermediate-term bond group has risen 18% in the past year.

As noted above, it's always tough to predict the markets, but I'd guess that investors should not assume they'll be getting returns of this magnitude every year. With that in mind, perhaps the best approach right now might be to smile, take a moment to be grateful for such gains, and then forget that the past 12 months ever happened.

Ten Years After
This month also marks the 10-year anniversary of the market top reached after the Internet-fueled bull market. (Or, if you prefer, it marks the start of the dot-com crash and subsequent bear market.)

That means many funds' 10-year returns look much different now than they did a year ago--or even more to the point, two or three years ago--when the bulk of the stunning late-'90s growth rally was still being included in those 10-year returns and rankings. I wrote about this phenomenon in November 2009 when the changes in rankings had already begun but had yet to take full effect. Now the numbers from the rally of the late 1990s and early 2000 have completely vanished from all funds' 10-year records.

As a result, the records of value funds have received quite a boost, for all of their lagging in the late '90s has disappeared from their 10-year records. Conversely, growth-oriented funds have lost their glory years. Examples of the drastic effects of these changes on the records and rankings of specific funds can be found in the November article. Make sure to keep this phenomenon in mind when you look at 10-year returns and rankings from this point onward.

Fortunately, there are ways to compensate. For example, instead of just looking at the standard three, five, and 10-year returns that we provide on useful as those can be for some purposes--you can also look at any time period you want, simply by changing the parameters. Go ahead and include the late '90s for a 13- or 14-year record that will cover two bear markets and three bull markets. Or make the fund's graph match the tenure of the current lead manager.

In order to set a customized time period, go to a fund's Performance page, and then click on Customize Interactive Chart on the far right at the top of the graph.

Extreme Investing
Unfortunately, the extreme market patterns of recent years make evaluating funds somewhat more difficult. For example, not only must you take Templeton Emerging Markets Small Cap's 170%-plus gain over the past 12 months with several grains of salt, you can't rely on the prior 12 months--from March 10, 2008, through March 9, 2009--to provide a reality check. During that stretch, the fund lost 65.4%. That's hardly helpful in trying to get a reasonable idea of the fund's long-term prospects.

You might think that the two periods could balance each other out, so that looking at its three-year return would offer a better clue of what to expect with this fund. But I would guess that its current three-year return of about 4%, annualized, isn't much help either. That may turn out to be the fund's annualized gain over the next 10 or 20 years, but there's just as much reason to think that the results could be quite different than that.

The good news is that there's a silver lining. With trailing-returns figures now burdened with issues, we're all forced to downplay them and instead evaluate funds based on factors other than returns and rankings, such as their strategy, the experience and tenure of their managers, the makeup of their portfolios, their turnover rates, their tax efficiency, their costs, and the qualities of their advisors. And that's not a bad thing at all.


Gregg Wolper does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.