Not All Recent Market Surprises Are Unpleasant

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Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Russ Kinnel, Morningstar's director of manager research and Morningstar Research Services, has been following investments for more than 25 years. But even he has found some aspects of the market's recent volatility to be surprising. He's joining me here today to discuss them. Russ, thank you so much for being here.

Russ Kinnel: Glad to join you.

Benz: We've been doing this for a long time, Russ, but I don't think either of us has ever experienced anything quite like what we've been going through recently. So, you highlighted some things that you did find particularly surprising about the recent volatility. One market segment that was hard-hit, especially when stocks were falling recently, was the municipal-bond market. Let's talk about why munis did fall so much during that period and whether you expect them to claw their way back.

Kinnel: Yeah, I was definitely surprised early on because early on we had a flight to quality in which we saw Treasury bonds, so the federal government's bonds, rally really strongly, especially at the long end. But at the same time, munis were actually selling off, so state and local government, that was selling off, and early on a lot of the explanations were kind of technical, like there wasn't a lot of support, liquidity had dried up. But I think over time it became more clear that it wasn't just technicals like that, there was actually some good fundamental reasons behind that. And that is as we've seen how hard-hit the economy is and what strains the states are under, all of a sudden all their tax revenues have gone away, but they're also scrambling to support all the people who have lost jobs as well as support the healthcare workers with gear and ventilators. And so when you look at it that way, it makes a lot more sense that munis would be under strain because the federal government can print money, their debt's not going to default, but it's a tougher spot for munis. Now, historically, munis have done very well and there have been few defaults, but I guess what I'm saying is I do understand the strain that they're under.

Benz: So, one I guess a benefit having come through this is that munis now have better yields than they did going into this period of volatility.

Kinnel: That's right. So, now you're getting a better yield. At least you're getting a little better payoff. I think munis are a decent buy now but not super attractive. They've sold off some, and there really is a tremendous strain under munis. Interestingly, we're talking about bailing out a lot of different parts of the economy: cruise lines, airlines, hotels, the auto industry, but states and local governments have not really been in the discussion.

Benz: Good point. Another surprise area for you, again in the realm of negative surprises, was just how badly financial stocks have gotten hit. So, let's talk about some of the factors going on there. Things working against financial stocks.

Kinnel: That's right. Compared with '07-08, financials came into this crisis in much better shape, much less leverage, their loans were being paid. So, they came into this situation in much better shape, and yet they're still getting hit really hard. I think a big part of that, of course, is just the economy has been hit really hard, and so financials are definitely feeling the brunt of that, a lot of the loans across the board, and not just in one sector, are not going to get paid back or there are going to be people miss some payments. And so financials have really taken it on the chin and again, a little like munis, with hindsight we can see why that is. And there's some good reasons for that. But again, you wouldn't have predicted that going in, or at least certainly I wouldn't have.

Benz: Right. Now over on the other side of the ledger in terms of more positive surprises, growth stocks you say have have surprised you a little bit because they have been relatively strong throughout this market swoon.

Kinnel: That's right. If you look at the pattern we had established before this, you had a great growth stock runup in the 90s. And then when we had a bear market, leadership flipped to value stocks because, of course, they seemed a lot cheaper. And then that switched again when we came to the '08-09 bear market, where value had been leading, it switched to growth. But this time growth has just kept on doing well. At least relative to value, the gaps have actually grown a fair amount between growth and value. And again, I do think there's some logic here. Obviously, a lot of the hardest-hit industries--economically cyclical ones--are on the value side. We already talked about financials. We know energy is having a horrible time because of oil prices. So, there is a logic and at the same time, what are we using more? We're using Amazon and Google a lot more. So again, there is some logic that growth would in general hold up better then value even though, again, you wouldn't have predicted that.

Benz: Speaking broadly, you say the strength of the recovery, the market recovery, has surprised you a little bit. We, I think on the total market index, are down like 11% or 12% currently here in mid-April. That seems like a really robust recovery, I guess given that some people are talking about potentially us entering into a depression.

Kinnel: It really is surprising. We go back to the previous two bear markets and in both cases you really overdid the selling, so long past the point where it seemed like a reasonable point to stop, where it seemed like all the bad news was out, stuff just kept getting cheaper and cheaper. This time, we've had a really tremendous rally. And again, if you could think about it, we were near all-time highs just a couple of months ago. And for us to only be off 13% for the year today is remarkable considering the economy's going to be in rough shape for a long time, I think. We're not just going to spring back in a month or two. And so, I do think it's a little odd that the market right now is only down slightly as it's a pretty modest sell-off at this point, now that you factor in we had one of the fastest 30% declines, but now we've recouped a big chunk of that. And so it really is a surprising, and when I think about it at this point, if anything, I'm more inclined to sell and buy.

Benz: I suspect that there will be more surprises in the days and months ahead. Russ, thank you so much for being here. It's always great to get your perspective.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.