Morningstar Advisor - October/November 2010 - 42

Morningstar Conversation

FPA Crescent FPACX
$14K

that. But we can think of other companies where it’s not going to be as easy as that.
Leggio: Ben, I assume you think that margin levels are sustainable for high-quality firms.
Morningstar Moderate Target Risk

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a sign that people are a bit less worried about deflation than they are now. But certainly, if we’re going to wind up with bond yields of 8% or 9%, associated with a real inflation scare, we would have to think stocks may well trade cheaply under those circumstances. Now, because we think that most stocks are real assets, that would provide a nice buying opportunity, and it looks like investors tend to demand a higher rate of return when there’s inflation, or don’t quite understand the positive impact that inflation will have on corporate cash flow. So, if we’re buying assets at fair value or better and we’re worried a little bit about inflation, it’s not that big a deal. The more confident we are that inflation is going to get out of hand, the more we would want to wait for a really good buying opportunity— not something trading at fair value, but something trading at a 25% or 35% discount to fair value. Today, we don’t see anything that is trading at a 25% to 35% discount to fair value, with the possible exception of dividend swaps in Europe, which is a pretty esoteric asset class.
Leggio: GMO’s long-term inflation assumption is still 2.5%, which is where it’s been for a number of years now. Inker: Yes. Honestly, we don’t think we’re good

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Category Moderate Allocation	 Morningstar Rating

Expense Ratio (%) 1.17 5-Yr Anl Total Rtn (%) 4.40 10

QQQQQ	
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Data as of Aug. 31, 2010

Jan-09 AnlJan-10 Rank Cat 5-Yr TR %

Inker: Yes. One of the things that scares us a little bit is that the past 12 to 15 years have been a pretty good time to be a company from a margin perspective, whether you’re looking at return on sales or ROE, or what have you. We have been in a pretty good place. But it has affected the high-quality guys less than the rest of the market. So today, we think that their margins are probably just about normal.

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GMO Global Balanced Asset Allocation GMWAX
$14K Morningstar Moderate Target Risk 12

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I do want to say one thing with regard to stocks versus bonds. The thing about bonds is that they’re nominal instruments. So they hate inflation and they love deflation. The way we think about it is that stocks are real instruments, but there’s a strong behavioral aspect to valuations. Investors in stocks do not like “flation”—they don’t like inflation, they don’t like deflation. So right now, we have bond yields that look to us as being consistent with mild deflation. As near as we can tell, stock-market investors are happy with nice, stable inflation of around 2%, or maybe 2.5%. As you get further away from that, either up or down, they get increasingly less happy. If we got rising interest rates because people stopped being quite so scared about a double dip and thought that deflation was off the table, and we got bond yields going back up into the fours and maybe as high as five, it’s not clear to us that stocks would care that much. Now, if we get deflation on its way to inflation, that would probably be a bad thing for stock valuations, because stocks around the world generally tend to trade at lower P/Es when we’ve got high inflation, just as they tend to trade at lower P/Es when we’ve got deflation. So we’re not worried that if the 10-year goes from 2.5% to 3.5% stocks would fall. We think it’s as likely under those circumstances that stocks might rise, because it might be

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Data as of Aug. 31, 2010

5-Yr Anl TR % Rank Cat 37

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at predicting inflation, which is probably why our inflation forecast has stuck around 2.5% for a long time. We don’t think the market is particularly good at predicting inflation either. So we’re not too impressed by how low bond yields are. We don’t think that means that the bond market knows that we are headed for a Japan-style event.

from rising inflation. Aon is in the insurance business but without the underwriting risk. They are just brokers. So if a building costs more to replace in 10 years, they benefit—annually. They’ve basically got a tithing. It’s a tax on economic activity. They also have a couple billion dollars sitting around on the balance sheet. If interest rates go up, then they’re going to get a higher return on

Thriving or Just Surviving?
Leggio: You have a few stocks in common. Steve, you mentioned Johnson & Johnson, but there’s also Kraft KFT, Wal-Mart WMT, and Anheuser-Busch InBev BUD. To your concern about rising rates, and maybe even the worst

42 Morningstar Advisor October/November 2010



Morningstar Advisor - October/November 2010

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2010

Morningstar Advisor - October/November 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What estate-planning strategies are you and your clients doing before the end of the year?
Next Steps for ETFs
Investment Briefs
Taking It Personal
A Model Practice
Find the Right Fit
Will REITs Put You in the Penthouse?
Prepare for the Worst
Tips for Common Family Situations
Might Makes Right
Built to Last
Four Picks for the Present
Tactical Strategies Miss Their Mark
Time to Hop on the Commodities Bandwagon?
Retailers Balance Caution and Catalysts
In Search of … Recession Survivors
Turmoil-Tested Small-Cap Funds
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Rise in Second Quarter
The Third Rail
Morningstar Advisor - October/November 2010 - Intro
Morningstar Advisor - October/November 2010 - Morningstar Advisor - October/November 2010
Morningstar Advisor - October/November 2010 - Cover2
Morningstar Advisor - October/November 2010 - 1
Morningstar Advisor - October/November 2010 - 2
Morningstar Advisor - October/November 2010 - Contents
Morningstar Advisor - October/November 2010 - 4
Morningstar Advisor - October/November 2010 - 5
Morningstar Advisor - October/November 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - October/November 2010 - 7
Morningstar Advisor - October/November 2010 - Contributors
Morningstar Advisor - October/November 2010 - Letter From the Editor
Morningstar Advisor - October/November 2010 - What estate-planning strategies are you and your clients doing before the end of the year?
Morningstar Advisor - October/November 2010 - 11
Morningstar Advisor - October/November 2010 - Next Steps for ETFs
Morningstar Advisor - October/November 2010 - 13
Morningstar Advisor - October/November 2010 - Investment Briefs
Morningstar Advisor - October/November 2010 - 15
Morningstar Advisor - October/November 2010 - 16
Morningstar Advisor - October/November 2010 - 17
Morningstar Advisor - October/November 2010 - Taking It Personal
Morningstar Advisor - October/November 2010 - 19
Morningstar Advisor - October/November 2010 - A Model Practice
Morningstar Advisor - October/November 2010 - 21
Morningstar Advisor - October/November 2010 - Find the Right Fit
Morningstar Advisor - October/November 2010 - 23
Morningstar Advisor - October/November 2010 - 24
Morningstar Advisor - October/November 2010 - 25
Morningstar Advisor - October/November 2010 - Will REITs Put You in the Penthouse?
Morningstar Advisor - October/November 2010 - 27
Morningstar Advisor - October/November 2010 - 28
Morningstar Advisor - October/November 2010 - 29
Morningstar Advisor - October/November 2010 - 30
Morningstar Advisor - October/November 2010 - 31
Morningstar Advisor - October/November 2010 - Prepare for the Worst
Morningstar Advisor - October/November 2010 - 33
Morningstar Advisor - October/November 2010 - 34
Morningstar Advisor - October/November 2010 - 35
Morningstar Advisor - October/November 2010 - Tips for Common Family Situations
Morningstar Advisor - October/November 2010 - 37
Morningstar Advisor - October/November 2010 - Might Makes Right
Morningstar Advisor - October/November 2010 - 39
Morningstar Advisor - October/November 2010 - 40
Morningstar Advisor - October/November 2010 - 41
Morningstar Advisor - October/November 2010 - 42
Morningstar Advisor - October/November 2010 - 43
Morningstar Advisor - October/November 2010 - 44
Morningstar Advisor - October/November 2010 - 45
Morningstar Advisor - October/November 2010 - Built to Last
Morningstar Advisor - October/November 2010 - 47
Morningstar Advisor - October/November 2010 - 48
Morningstar Advisor - October/November 2010 - 49
Morningstar Advisor - October/November 2010 - Four Picks for the Present
Morningstar Advisor - October/November 2010 - 51
Morningstar Advisor - October/November 2010 - Tactical Strategies Miss Their Mark
Morningstar Advisor - October/November 2010 - 53
Morningstar Advisor - October/November 2010 - 54
Morningstar Advisor - October/November 2010 - 55
Morningstar Advisor - October/November 2010 - 56
Morningstar Advisor - October/November 2010 - 57
Morningstar Advisor - October/November 2010 - Time to Hop on the Commodities Bandwagon?
Morningstar Advisor - October/November 2010 - 59
Morningstar Advisor - October/November 2010 - 60
Morningstar Advisor - October/November 2010 - Retailers Balance Caution and Catalysts
Morningstar Advisor - October/November 2010 - 62
Morningstar Advisor - October/November 2010 - 63
Morningstar Advisor - October/November 2010 - 64
Morningstar Advisor - October/November 2010 - 65
Morningstar Advisor - October/November 2010 - In Search of … Recession Survivors
Morningstar Advisor - October/November 2010 - 67
Morningstar Advisor - October/November 2010 - Turmoil-Tested Small-Cap Funds
Morningstar Advisor - October/November 2010 - 69
Morningstar Advisor - October/November 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - October/November 2010 - 71
Morningstar Advisor - October/November 2010 - 72
Morningstar Advisor - October/November 2010 - 73
Morningstar Advisor - October/November 2010 - 50 Most Popular ETFs
Morningstar Advisor - October/November 2010 - 75
Morningstar Advisor - October/November 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - October/November 2010 - 77
Morningstar Advisor - October/November 2010 - VA Sales Rise in Second Quarter
Morningstar Advisor - October/November 2010 - 79
Morningstar Advisor - October/November 2010 - The Third Rail
Morningstar Advisor - October/November 2010 - Cover3
Morningstar Advisor - October/November 2010 - Cover4
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