Morningstar Advisor - August/September 2009 - 20

Investment Briefs Middle-of-the-Road Strategy Can Pay off in the End As we discuss in this issue’s Spotlight (page 34), small caps historically have outperformed large caps as the economy emerges from recessions. Since the market lows in March, small caps have handily outperformed larger stocks. Whether this trend will continue is anyone’s guess, but a look at the past shows that the outperformance of small stocks and large stocks alternates over time and that these shifts in leadership between cycles can vary in length and magnitude, Morningstar research and communications manager Jim Licato says. Investors who don’t want to get caught up in the commotion of guessing whether a particular cycle has started may want to consider mid-caps. “What makes mid-caps potentially good investments is that they are large enough to have strong brand recognition yet small enough to experience solid growth,” Licato says. Licato points to the boom and bust of the 1990s and early 2000s as an example of how investors can benefit from mid-caps. In the 1990s, mid-cap stocks performed well— not as well as large-cap stocks but better than small caps. When the markets turned during the early 2000s, mid-caps weathered the turbulent market better than large stocks while slightly trailing small stocks. In both time periods, mid-cap investments provided consistent performance independent of the market’s direction. From January 2008 through May 2009, mid-cap stocks slightly lagged both large- and small-cap stocks, with small caps leading the way. Whether large caps reassert themselves in this uneven market or small caps manage to stay on top, mid-cap investments should remain a solid option for investors who prefer not to predict the future. Licato makes one more point: He examined the risk and return statistics of all three size groupings over the past 15 years and found that mid-caps produced the highest return of all three (6.5%) for the least amount of risk, as measured by standard deviation (19.6%). A Contrarian’s Take on Treasuries Over on MorningstarAdvisor.com’s Markets & Economy blog, financial advisor and blog contributor Janet Briaud gives a few reasons why it makes sense to have some Treasury bonds in your clients’ portfolios: 1. There is still the possibility of deflation. “In fact, in the Financial $3,661 Times’ Economic Outlook (the week of June 14), we see that $2,358 we are already experiencing some deflation: $2,057 The annual CPI rate has fallen to -0.9%,” Briaud writes. 2. The prices of goods are declining, especially large items such as houses, electronics, and cars. As investors wait on the sidelines for even cheaper prices, you have deflation. 3. There is a major shift from spending freely by investors and businesses to a new frugality. “I believe that this is a long-term trend as investors stop their high spending using leverage and instead pay off their heavy debt loads,” Briaud writes. “The emphasis now is on cutting back on spending or taking care of what you have.” 4. The unemployment rate is now more than 9%, but when underemployment is factored in, the rate is more than 15%. 5. One cannot rule out the possibility of the market testing the new lows, at which time investors will flee to Treasuries. Booming Market: Growth of $1,000 1995 through 1999 $5,000 Large Cap Mid-Cap Small Cap $3,661 2,358 2,057 1,000 1995 1996 1997 1998 1999 2000 Sagging Market: Growth of $1,000 2000 through 2002 $2,000 1995 Large Cap 1996 1997 Mid-Cap 1998 Small Cap 1999 2000 1,000 $903 836 576 400 2000 2001 2002 2003 Risk and Return, Last 15 Years Geometric Mean Standard Deviation Large Cap Mid-Cap Small Cap Morningstar data 6.2 6.5 6.4 22.2 19.6 20.4 6. “As a contrarian, I am always interested in the least-loved asset,” Briaud writes. “I have found that when everyone is saying the same thing, everyone is often wrong. Investors today believe that the interest rate on 10-year Treasuries is too low. But if, for example, we experience -1% inflation and we make 3% on our Treasury bond, a real return of 4% on our fixed income is quite attractive.” 20 Morningstar Advisor August /September 2009

http://www.MorningstarAdvisor.com

Morningstar Advisor - August/September 2009

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2009