Morningstar Advisor - February/March 2009 - 20

Investment Briefs Big Year Follows Periods of Dismal Performance Large-cap stocks have failed to earn calendaryear returns above zero for two or more consecutive years only four times in the past 83 years, says Jim Licato, a Morningstar researcher. After each instance, he says, a year of above-average returns followed. “What this illustrates,” Licato says, “is that investors who stop making regular investments during market downturns can miss out on future opportunities.” Licato applied the same analysis to small-cap stocks and found that there have been five instances, including 2007 and 2008, in which small-cap stocks produced a negative annual return for two or more straight years. Similar to large-cap stocks, the negative returns of small stocks were followed by a year of above-average returns. These patterns are not guaranteed to repeat themselves, and there’s no telling how long a period of negative returns might last. But they illustrate the market’s potential and one of the reasons why clients need to stay focused on their investment plans. “It is imperative to remind clients that a disciplined investment approach is still the best strategy for handling market downturns,” Licato says. This approach includes maintaining a well-diversified portfolio and staying committed to a long-term investment plan. Those who attempt to time the market run the risk of missing out on periods of exceptional returns and compounding their misery. says that even the current ripe valuations in the U.S. multinationals pale in comparison to the valuations of European and Japanese firms. Looking at price/trailing earnings ratios as of Jan. 6, U.S. large caps showed a valuation about 11 times trailing earnings. The Japanese stocks in iShares S&P/TOPIX 150 ITF traded for 9 times trailing earnings, and European giant caps in iShares S&P Europe 350 IEV cost 7.5 times trailing earnings. It’s the same story with operating cash flows and dividends. The companies of SPDRs traded for 7 times operating cash flows, seemingly a reasonable deal. “Yet here, too, we find better opportunities abroad,” Kay says. “The S&P Europe 350 multinationals sell for 5.5 times trailing operating cash flows, and the Japanese S&P/TOPIX 150 trades for an incredible 4 times cash flows.” For dividend yields, the 3.5% yield on SPDRs fails to match the 3.7% trailing yield on Japanese large caps and doesn’t approach the 7% trailing yield on European large caps. The final piece of the puzzle is currency. Kay says that pressures on the dollar’s value could easily boost returns for firms earning more of their profits in Europe. The yen may not have the euro’s advantages as a reserve currency or substantial economic growth driving its value, but Kay doesn’t expect it to devalue and hold back U.S. dollar returns on Japanese equities. “For those investors looking to pick high-quality companies guaranteed to survive whatever comes next,” Kays says, “we believe the sweetest-looking fruit lies across the oceans.” Sweet ETF Deals Appear to Be Overseas Because of lower market valuations overseas and a belief that the dollar will weaken with time, Morningstar ETF analyst Bradley Kay says that developed-markets ETFs could be primed for a period of outperformance compared with U.S. offerings such as SPDRs SPY. Focusing on global giant-cap firms, Bradley Large Caps Bounce after Years of Consecutive Negative Returns 60% Return 54 40 20.3 20 37 29 0 –8 –20 –8 –0.4 –9.8 –11.8 –15 –26 –9 –12 –22 –25 Intriguing Index Funds Not Named Vanguard When most investors think about index funds, the first name that likely comes to mind is Vanguard—and for good reason. But Morningstar mutual fund analyst Greg Brown put together a list of four interesting index funds from Bridgeway and DFA that, while not for the faint of heart, are worthy of your attention. –40 –43 –60 1929 1930 1931 1932 1933 1939 1940 1941 1942 1973 1974 1975 2000 2001 2002 2003 Large-cap stocks represented by the S&P 500 Index. The average annual return from 1926 to 2008 of the S&P 500 is 9.6%. 20 Morningstar Advisor February/March 2009

Morningstar Advisor - February/March 2009

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