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Hard to Be Upset About Stocks

U.S. and most foreign equities saw strong growth during the first half of 2013, but this healthy bull market could be a ripe time for investors to rebalance their portfolios.

Christine Benz: Hi. I’m Christine Benz for Despite some gyrations toward the end of the second quarter, stock funds are having a very good year so far in 2013. Joining me to provide some color on recent stock-fund performance is Shannon Zimmerman. He is associate director of fund analysis with Morningstar.

Shannon, thank you so much for being here.

Shannon Zimmerman: Good to be with you, Christine.

Benz: Shannon, let’s talk about domestic equity to start. Last year I think it was sort of across the board in terms of strength. This year you note that are a few more gradations, that there have been stronger pockets and weaker pockets, but strong performance overall.

Zimmerman: Exactly right. It would be tough to be a disappointed investor in the environment that we’ve had so far year to date in 2013. But exactly right, there have been gradations across market-cap ranges in particular on the domestic-equity side. So if you look at Morningstar’s diversified domestic-equity categories that are divvied up in terms of market cap and valuation spectrum, all of our small-cap categories are at the top of the performance table, beginning with small-cap growth.

The gradations between the small-cap peer group is quite small. They’re all up about 20%; small growth is slightly ahead of its rivals, small blend and small value. As you look down, mid-cap almost to a category is at a second tier, and then large cap at the very bottom. But still large-cap growth is the weakest-performing domestic-equity category, and it’s up 15% on the year. So, it’s hard to be a disappointed investor, I say.

Benz: How about the value-to-growth spectrum, are you seeing that kind of gradation there, as well?

Zimmerman: No, no, not at all, and certainly not nearly as dramatically as you see it in terms of market cap and the impact that has had. If you look at the small cap group, exactly right, small growth is at the top of the list, but only marginally so. But down the spectrum, to the large-cap categories, large growth is at the very bottom of the category, and it’s kind of mixed up in between. There is no clear rhyme or reason in terms of what’s outperformed as gauged by valuation.


Benz: So let’s home in on a few specific funds, widely held funds. Let’s start with the total stock market index tracker, Vanguard’s big fund. If you hold that fund, how have you done year to date?

Zimmerman: Well, if you hold that fund, you hold it with a lot of other people with a lot of other money. We were just talking before we began taping, a quarter-trillion dollars is in that fund. It’s massive. You’ve done well. Through the end of June you would have gained about 14%. It’s worth noting, and maybe we’ll pick up on this in a little bit, but this is a pretty lengthy bull run at this point. And Mike Rawson, our analyst who covers the Total Stock Market fund, points out that Morningstar’s equity research group regards the holdings in that fund as being fairly valued. Now, that’s not a screaming sell, not a screaming buy; probably it’s a screaming "do nothing," but just be aware that in terms of history this is a pretty lengthy bull run.

Benz: Let’s about another biggie widely held fund; this is Fidelity Contrafund. How is that one doing year to date?

Zimmerman: It’s doing well in absolute terms. Certainly it’s up about 11.4% year to date through the end of June. In relative terms, it’s still above-average, but only slightly above-average. It’s in the 41st percentile of its category. That’s a fund that unlike Total Stock Market, which is a passive fund, a quarter-trillion dollars is a lot of money, but still it’s less significant for an index fund than it would be for Will Danoff in managing Contrafund. He has between this fund, Contrafund, and another one that’s quite similar to it over $100 billion just in fund assets alone, and then there may be separately managed accounts in other vehicles that he runs in the same strategy that could boost the assets that he has under management.

He has not been weakened by the massive amount of assets that he has run, but in some ways that’s gravity-defying. Typically what you find is that even with a large-cap-focused fund, which this is, at that level of assets you start to become concerned about asset bloat. How is it possible to put all of that money to work behind just your best ideas? You end up expanding the portfolio beyond the names that you would want to invest in because you have to put that money to work somewhere and you can’t keep stuffing into the names you already have. But so far, he has not been held back by the asset-bloat problem.

Benz: Yeah, I remember we were hand-wringing about its asset size 10 years ago and it’s still done all right. Let’s talk about Dodge & Cox Stock, not quite as large as these other two, let’s talk about how its performance has been.

Zimmerman: So, what a difference a market cycle makes, in some way. So it has about $40 billion in assets. So, yes, it's large, but not as large as the other funds. But Dodge & Cox Stock and the investment committee that runs those funds have a reputation, and it’s a warranted reputation for being buttoned-down and conservative. Maybe that part of their reputation is not as warranted as some people might think because they really don’t care too much about quarter-over-quarter or even year-over-year volatility. And provided their investment thesis remains intact on an individual stock or a whole block of stocks that they own, they’re going to stick to their guns and with that name, even if along the way they experience some dips. Hewlett-Packard is a great example in its turnaround story now, and the fund has benefited from holding that position. There are lot of people who criticized them for when it looked like Hewlett-Packard was sort of in the doldrums permanently. But it’s come roaring back and so has this fund. It’s five-year mark is in the 39th percentile of its category, but year-to-date it’s in the 9th percentile of the category, so it’s doing quite well.

Benz: Shannon, let’s segue to international funds. Talk about what the headlines are for people who are eyeballing their international funds performance.

Zimmerman: It’s a fairly straightforward story because it’s really two blocks of performance. It’s Japan and everybody else, except for two of our international categories. People who are invested in international funds have also done quite well; not as well as on the domestic-equity side, but Japan has done remarkably well, a 25% return year to date through the end of the July 10 market close for that category. There is a disconnect between what the Japanese economy isn’t doing and what the Japanese stock market has been doing, and I guess it’s trying to anticipate, in the way that stock markets do, economic recovery. The Bank of Japan is being quite aggressive in terms of trying to stimulate the economy, and which kind of flies in the face of  their history because they have a reputation for the lost decade of the 1990s, not having done enough. They seem to be overcorrecting for that.

Benz: Shannon, one pocket of weakness, though, does seem to be in emerging markets. Let's talk about what’s going on there. It’s obviously a broad basket, but what are the key areas of weakness?

Zimmerman: Emerging markets are volatile as usual, right? It’s a weak pocket right now. Of the international fund categories, there are only two that are negative year to date, and they’re substantially negative, too. One is India equity, an emerging-markets category, and the other is Latin America stock, an emerging-markets category, as well. Latin America stock is almost off 20% and India equity, the last time I looked, which was five minutes ago, is off about 14% year to date. So, why would that be? The India picture seems clearer to me than the Latin America picture does. India had a fantastic year last year. A part of that has to be investors pulling back and reining in their exposures there because they want to take profits in a very volatile part of the market after having done quite well. There is more to the India story than just that, but that seems to be the main driver.

The Latin America story is not as cut-and-dried, and tougher to ferret out. It has something to do with Mexico, but what exactly it is in terms of investors, not aversion, but reluctance to keep money invested there isn’t entirely clear.

Benz: So, I’d like to take a step back. You alluded to the fact that this bull market has run on for some time. I think if investors are looking at their statements and seeing there are very strong recent gains, they might naturally have a tendency to want to pull back, maybe rebalance out of equities. What should investors be thinking about as they’re managing their portfolios today in light of a very strong extended equity market?

Zimmerman: You must be talking about the sensible investors, right? "Look, the market is up. Maybe I should think about reducing my exposure." That’s right. You want to rebalance into the weaker parts of your portfolio, and you're always going to pick best-in-class players relative to your timeline and your risk tolerance. Then once you get that asset allocation that works for you, as things go up, dial back and deploy those gains into the parts of your portfolio that maybe haven’t done quite as well. Historically though, just to reiterate, the average bull market since the early 1960s, which is a relevant period--you can go back as far as 1900, but how relevant is 1900 to now. 1960 is also an arbitrary market in some ways, but it’s more like our time than previous periods.

So since 1962, the bull markets have averaged about four years. We’re now in year five of a very healthy bull market. There have certainly been bull markets that have gone on for longer and bull markets that have been much more powerful in terms of the returns that have been generated. Still, I think, to your point, investors who want to be sensible about their asset allocation should just make sure that they are still on track in terms of things not getting lopsided relative to what their blueprint was. This is because parts of the market--small caps this year, for instance--rise up, and you end up with an outsized allocation to a part of the market that is more volatile and that maybe you wouldn’t have elected to be in if you’re making that choice rather than having the market make it for you.

Benz: So have that rebalancing plan in place and also keep an eye on those Style Box and sector exposures as you’re deciding what to change.

Zimmerman: Absolutely.

Benz: Shannon, thank you so much for being here.

Zimmerman: Sure thing. Good to be with you.

Benz: Thanks for watching. I’m Christine Benz for

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