Our Take on the First Quarter

Markets were remarkably resilient at the start of 2011 as investors held their nerve despite a series of geopolitical and economic crises. The broad-based Morningstar U.S. Index was up 4.86% during the last 13 weeks ended March 29. The index has tacked on 16.09% during the last 12 months and is even up 3.00% during the last five years.

The world was rocked in January when Tunisian president Zine El Abidine Ben Ali resigned in January after widespread protests broke out in the North African country. The unrest spread across the region eventually forcing out Egyptian leader Hosni Mubarak, igniting a rebellion in Libya and destabilizing several other regimes. The growing uncertainty in the region and continued demand from emerging economies sent the price of oil higher.

In Europe, the sovereign debt fear that dominated the headlines last summer reared its head again. Credit spreads steadily rose throughout the quarter as worries increased that the EU framework for bailing out struggling countries would not be robust enough to stave off a crisis. Portugal's failure to pass austerity measures and the subsequent resignation of the country's prime minister in March highlighted the challenge of balancing budgets.

Japan was hit by a devastating earthquake and Tsunami March 11, causing extensive damage in the northeastern portion of the country. The earthquake damaged the cooling systems at the Fukushima Nuclear Power Plant leading to a nuclear crisis and the evacuation of the areas immediately surrounding the plant.

On top of all of this, food and energy inflation picked up in the quarter. Rising prices could force the Federal Reserve to tighten monetary policy sooner than it had hoped and short-circuit the recovery.

But not all is bleak on the economic front. Morningstar's Bob Johnson believes that gross domestic product can still increase by 3.50% to 4.00% in 2011 as long as inflation doesn't get completely out of control. Employment data has also looked better, with initial unemployment claims steadily dropping and the unemployment rate falling to 9.00% in February.

Mergers and acquisitions were back in the news, notably with  AT&T's (T) surprise announcement it was acquiring T-Mobile USA from  Deutsche Telekom (DTEGY) for $39 billion. IPOs, continued apace with large offerings from  HCA (HCA) ($3.6 billion),  Kinder Morgan (KMI) ($2.8 billion), and Nielsen NSLN ($1.6 billion). Many firms are returning to the market after being taken over by private equity firms during the boom of the mid-2000s.

Mid-cap stocks led the charge in the first quarter, rising 6.59% during the last 13 weeks. Small-cap stocks were up 5.69%, while large-cap continued to bring up the rear, rising 4.29% in the quarter, according to Morningstar indexes. Value stocks (up 6.04%) outpaced growth (up 3.83%) and core (up 4.72%) stocks during the time period.

All sectors posted a positive return for quarter with energy leading the way with a 14.78% return. Media, hardware, and financial services were next rising 9.92%, 7.77%, and 4.58% respectively. Consumer services, consumer goods, and software were the laggards in the first-quarter, rising 0.69%, 1.21%, and 2.07% respectively.

Our analysts believe that stocks are slightly (3%) overvalued at the moment, and Morningstar vice president of global equity and credit research Heather Brilliant doesn't see stocks as a screaming buy at the moment.

In the mutual fund world, the best-performing domestic-equity category was equity energy which gained 13.00% in the quarter. Natural resources and small growth were next, each gaining more than 6.00%. Consumer discretionary (up 1.20%), consumer staples (up 1.30%), and financials (up 2.10%) were the weakest performers in the quarter.

The fixed-income market stabilized after the sell-off toward the end of 2010. The Morningstar Government Bond Index rose 0.80% during the last quarter with the Long-Term Index gaining 1.60%. Corporate bonds fared better with the Morningstar Corporate Bond Index rising 2.00% during the last 13 weeks. The Morningstar TIPS Index was up 3.00% for the quarter.

The first quarter of 2011 was notable not only for the unexpected string of global crises but for resilience of the markets through them. With stocks looking fully valued, the real question now is how much longer investors will be willing to brush off potential concerns and continue to look to the upside.