(PUB) Investing 2016

9

November 2016

Morningstar FundInvestor

and five years. Meanwhile, yield-chasing has pushed utilities and other value stocks with big dividends to new heights. Possible Catalysts for the Next Bear Market Again, the above is not grounds for a prediction, but it’s worth being risk-aware. Among U.S. funds in the Morningstar 500 , Yacktman Focused YAFFX and Yacktman Service YACKX have the most consumer staples exposure at about 28% and 29% of assets, respectively. Both funds have long maintained overweightings in those two sectors. Perhaps unsur- prisingly, both funds outperformed most of their peers during the 2015 – 16 correction and the 2011 bear market. It’s also worth noting that both funds have close to 20% in cash, which provides protection during a bear market. If debt drives the next bear market, then shareholders of funds such as Osterweis OSTFX , Fidelity Lever- aged Company Stock FLVCX , First Eagle Fund of America FEAFX , Janus Contrarian JSVAX , and Akre Focus AKREX all have cause for concern. All five of these funds have debt/capital ratios greater than 50% . For comparison, the S & P 500 has average debt/capital of 41 . 8% , which is itself higher than the level in 2007 . Conclusion Unfortunately, there are no absolute guidelines for protecting one’s portfolio during a bear market. The best one can do is prepare in advance by suitably diversifying, which perhaps includes an allocation to high-quality bonds—Treasuries in particular—since they tend to do well when stocks fall. It’s also critical to understand the risks inherent in each fund one owns. In addition, don’t try to fight the last war. Don’t assume that what worked recently or in the previous bear market will work next time. But, perhaps most importantly, when the next bear market strikes, remain calm. A bear market is the worst time to be reactionary. That’s the time to revisit your original investment plan and remember why you own what you own. K Contact Kevin McDevitt at kevin.mcdevitt@morningstar.com

5 Bear Markets by Sector and Style

Peak-to-trough

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–

–

–

–

7/18/98 10/8/98

3/22/00 3/11/03

10/7/07 3/9/09

4/29/11 10/3/11

5/21/15 2/11/16

Russell 3000 Consumer Disc

-30.21

-45.04

-56.45

-17.63

-12.67

19.51

-31.28

-5.51

Russell 3000 Consumer Staples

-9.04

1.45

-32.16

Russell 3000 Energy

-6.39

-15.34

-47.14

-28.30

-33.24

-76.18

Russell 3000 Financials

-4.94

-28.27

-17.49

Russell 3000 Health Care

-16.09

-12.39

-37.77

-14.27

-17.22

-28.95

Russell 3000 Materials & Processing

-20.81

-15.96

-62.76

-22.20

-78.14

Russell 3000 Technology

-24.03

-51.55

-16.08

-14.11

Russell 3000 Telecommunication

-55.66

-19.28

-23.59

2.02

3.78

Russell 3000 Utilities

-57.15

-45.97

-5.72

Russell 3000

-21.04

-43.45

-55.45

-20.19

-14.72

-23.27 -61.46 -18.64 -19.62

-51.16 -59.77

-18.47 -21.87

-13.13 -16.33

Russell 3000 Growth

Russell 3000 Value

Blue : Best-performing sector/style. Purple : Worst-performing sector/style.

round or two of pain. Financials were not the best-per- forming sector heading into the mid- 2011 downturn, but they were still one of the hardest-hit sectors. Simi- larly, growth stocks had already been doing better than value stocks heading into the 2015 correction, but they still held up better during the downturn. Based on the past 20 or so years of history, consumer staples (or consumer defensive) stocks would seem to be ripe for mean reversion (that is, a beat- down). Consumer staples have survived the past five consecutive bear markets far better than the over- all market. Heck, the Russell 3000 Consumer Staples Index even made money during the 2000 – 03 bear market and the 2015 – 16 correction. But all that success seems to be reflected in the sector’s average price multiples, which are greater than those of the rest of the Russell 3000 Index nearly across the board. Plus, it’s worth noting that the group has the second-highest average debt/capital ratio ( 51 . 6% ) among the sectors. (Only utilities have more debt on average, but that stands to reason given their business model.) So, if the catalyst for the next bear market is either price-driven or debt-driven, funds with substantial consumer staples exposure could be in trouble. Growth-oriented technology is another sector to be mindful of given that it has beaten the broader market over the past three