Morningstar Advisor - Winter 2008 - 58

Morningstar Conversation representing a 40-year peak as a percentage of GDP at a time when wages are an all-time minimum share of GDP. I think the notion that you can take these peak earnings and extrapolate historical earnings growth is just naïve. Even if it continues for another year or so, watch out for the political backlash. It’ll be huge. Now, earnings do revert to the mean over time. Historically, they tend to grow 1% to 2% faster than CPI over a very long span. Recently, they’ve done far better than that, and there are folks who extrapolate that growth and say, “Well, they’ve grown faster and they’ll continue to grow faster.” I don’t think that’s plausible. If you go back historically and ask what’s the precedent for 8% earnings growth—the consensus expectation off of peak earnings— there is none in the entire history. One of the things that strikes me as I look at the market today is that some of the best values are large-cap companies. In my mind, that argues in favor of traditional indexes. Kunal Kapoor KK: But some would argue that a lot of those earnings are coming from outside the United States. Doesn’t that change the picture somewhat? RA: Absolutely correct. But it’s naïve to assume that U.S. companies can earn a growing share of non-U.S.-sourced profits relative to the domestic providers. KK: They certainly seem to be doing okay, even small, most of the time, the market pays a premium for large companies and discounts small companies. Fundamental Index in that environment says, “Well, wait a minute. These companies are bigger than they’re given credit for. Let’s weight them according to their economic scale.” So you have a small-cap tilt. Today, it’s the opposite. The market’s paying a premium for small caps, so Fundamental Index says, “Well, wait a minute. These companies aren’t that big. Let’s reweight them to their economic scale,” which creates a large-cap tilt. It’s a myth that this idea has a structural small-cap tilt. It only has a small-cap tilt when the market’s pricing small caps at a discount. We are asked, “Aren’t you going to be disappointed if big caps rebound and outperform small caps?” No. We’ll be pleased, because we now have a large-cap tilt. KK: Speaking about the broader market, let’s shift gears a little bit and talk about your view of the markets right now. You indicated earlier that you’re not optimistic on equities. RA: I have a cautious view on equities. The if they’re not taking a majority share. simple fact is most of our clients and most clients of financial advisors will have most of their money in stocks. So the question is to what extent that you really have to have stocks in the portfolio. If you’re an FA and you say, “Get out of stocks,” and you’re wrong, that’s a career-ending decision. Given that equities will remain a major part of the portfolio, what equity structures do best in a weak market? That’s the beauty of Fundamental Index in that context. But I think equities have some vulnerabilities. The vulnerabilities for equities today relate largely to the fact that we have earnings RA: But how sustainable is that as the domestic competition in these overseas markets get up to speed on how to compete effectively? What we find historically is that when earnings are 50% to 60% above their 10-year average, as they are today, the subsequent 10-year growth in earnings averages a little less than inflation, a little negative in real terms, which would mean very low single-digit growth, 1% or 2% in notional terms over the next 10 years. The market is expecting much faster growth, so 58 Morningstar Advisor Winter 2008

Morningstar Advisor - Winter 2008

Table of Contents for the Digital Edition of Morningstar Advisor - Winter 2008

Morningstar Advisor - Winter 2008
Contents
Letter from the Editor
Inbox
How Do You Use the Morningstar Style Box?
Real Estate Investing Goes Global
The Golden Touch
Investment Briefs
Learning to Fly with Equity Options
Another Block in Building a Portfolio
In a League of Their Own
Unlock the Box
Fashion Change
The View from the Investment Side
Unpredictable Style
Weighting the Fundamentals
Wire-to-Wire Consistency
The Secret's Out
Focus on Financials
Strongest Homebuilders Will Withstand the Wrecking Ball
Breaking Style Conventions
Playing It Safe with Financials
Back to Bond School
Mutual Fund Analyst Picks
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
The Style Counsel
Morningstar Advisor - Winter 2008 - Intro
Morningstar Advisor - Winter 2008 - Morningstar Advisor - Winter 2008
Morningstar Advisor - Winter 2008 - Cover2
Morningstar Advisor - Winter 2008 - 1
Morningstar Advisor - Winter 2008 - 2
Morningstar Advisor - Winter 2008 - Contents
Morningstar Advisor - Winter 2008 - 4
Morningstar Advisor - Winter 2008 - 5
Morningstar Advisor - Winter 2008 - 6
Morningstar Advisor - Winter 2008 - Letter from the Editor
Morningstar Advisor - Winter 2008 - 8
Morningstar Advisor - Winter 2008 - Inbox
Morningstar Advisor - Winter 2008 - How Do You Use the Morningstar Style Box?
Morningstar Advisor - Winter 2008 - 11
Morningstar Advisor - Winter 2008 - Real Estate Investing Goes Global
Morningstar Advisor - Winter 2008 - 13
Morningstar Advisor - Winter 2008 - 14
Morningstar Advisor - Winter 2008 - The Golden Touch
Morningstar Advisor - Winter 2008 - 16
Morningstar Advisor - Winter 2008 - 17
Morningstar Advisor - Winter 2008 - Investment Briefs
Morningstar Advisor - Winter 2008 - 19
Morningstar Advisor - Winter 2008 - 20
Morningstar Advisor - Winter 2008 - 21
Morningstar Advisor - Winter 2008 - Learning to Fly with Equity Options
Morningstar Advisor - Winter 2008 - 23
Morningstar Advisor - Winter 2008 - 24
Morningstar Advisor - Winter 2008 - 25
Morningstar Advisor - Winter 2008 - Another Block in Building a Portfolio
Morningstar Advisor - Winter 2008 - 27
Morningstar Advisor - Winter 2008 - 28
Morningstar Advisor - Winter 2008 - 29
Morningstar Advisor - Winter 2008 - In a League of Their Own
Morningstar Advisor - Winter 2008 - 31
Morningstar Advisor - Winter 2008 - 32
Morningstar Advisor - Winter 2008 - 33
Morningstar Advisor - Winter 2008 - 34
Morningstar Advisor - Winter 2008 - 35
Morningstar Advisor - Winter 2008 - Unlock the Box
Morningstar Advisor - Winter 2008 - 37
Morningstar Advisor - Winter 2008 - 38
Morningstar Advisor - Winter 2008 - 39
Morningstar Advisor - Winter 2008 - Fashion Change
Morningstar Advisor - Winter 2008 - 41
Morningstar Advisor - Winter 2008 - 42
Morningstar Advisor - Winter 2008 - 43
Morningstar Advisor - Winter 2008 - The View from the Investment Side
Morningstar Advisor - Winter 2008 - 45
Morningstar Advisor - Winter 2008 - 46
Morningstar Advisor - Winter 2008 - 47
Morningstar Advisor - Winter 2008 - 48
Morningstar Advisor - Winter 2008 - 49
Morningstar Advisor - Winter 2008 - 50
Morningstar Advisor - Winter 2008 - 51
Morningstar Advisor - Winter 2008 - Unpredictable Style
Morningstar Advisor - Winter 2008 - 53
Morningstar Advisor - Winter 2008 - Weighting the Fundamentals
Morningstar Advisor - Winter 2008 - 55
Morningstar Advisor - Winter 2008 - 56
Morningstar Advisor - Winter 2008 - 57
Morningstar Advisor - Winter 2008 - 58
Morningstar Advisor - Winter 2008 - 59
Morningstar Advisor - Winter 2008 - 60
Morningstar Advisor - Winter 2008 - 61
Morningstar Advisor - Winter 2008 - Wire-to-Wire Consistency
Morningstar Advisor - Winter 2008 - 63
Morningstar Advisor - Winter 2008 - 64
Morningstar Advisor - Winter 2008 - 65
Morningstar Advisor - Winter 2008 - The Secret's Out
Morningstar Advisor - Winter 2008 - 67
Morningstar Advisor - Winter 2008 - 68
Morningstar Advisor - Winter 2008 - 69
Morningstar Advisor - Winter 2008 - Focus on Financials
Morningstar Advisor - Winter 2008 - 71
Morningstar Advisor - Winter 2008 - 72
Morningstar Advisor - Winter 2008 - 73
Morningstar Advisor - Winter 2008 - Strongest Homebuilders Will Withstand the Wrecking Ball
Morningstar Advisor - Winter 2008 - 75
Morningstar Advisor - Winter 2008 - Breaking Style Conventions
Morningstar Advisor - Winter 2008 - 77
Morningstar Advisor - Winter 2008 - Playing It Safe with Financials
Morningstar Advisor - Winter 2008 - 79
Morningstar Advisor - Winter 2008 - 80
Morningstar Advisor - Winter 2008 - Back to Bond School
Morningstar Advisor - Winter 2008 - 82
Morningstar Advisor - Winter 2008 - Mutual Fund Analyst Picks
Morningstar Advisor - Winter 2008 - 84
Morningstar Advisor - Winter 2008 - 85
Morningstar Advisor - Winter 2008 - 86
Morningstar Advisor - Winter 2008 - 87
Morningstar Advisor - Winter 2008 - Undervalued Stocks
Morningstar Advisor - Winter 2008 - 89
Morningstar Advisor - Winter 2008 - 90
Morningstar Advisor - Winter 2008 - 91
Morningstar Advisor - Winter 2008 - Most Popular Variable Annuities
Morningstar Advisor - Winter 2008 - 93
Morningstar Advisor - Winter 2008 - New at Morningstar
Morningstar Advisor - Winter 2008 - 95
Morningstar Advisor - Winter 2008 - The Style Counsel
Morningstar Advisor - Winter 2008 - Cover3
Morningstar Advisor - Winter 2008 - Cover4
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