(PUB) Investing 2016

Morningstar FundInvestor

November 2016

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

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

–

bear market and the

2015

–

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

(

) 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

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

–

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

500

has average

debt/capital of

, 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.

Contact Kevin McDevitt at

kevin.mcdevitt@morningstar.com

5 Bear Markets by Sector and Style

Peak-to-trough

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

Russell 3000 Consumer Staples

-9.04

19.51

-31.28

-5.51

1.45

Russell 3000 Energy

-6.39

-15.34

-47.14

-28.30

-32.16

Russell 3000 Financials

-33.24

-4.94

-76.18

-28.27

-17.49

Russell 3000 Health Care

-16.09

-12.39

-37.77

-14.27

-17.22

Russell 3000 Materials & Processing

-20.81

-15.96

-62.76

-28.95

-22.20

Russell 3000 Technology

-24.03

-78.14

-51.55

-16.08

-14.11

Russell 3000 Telecommunication

-55.66

-19.28

-23.59

Russell 3000 Utilities

2.02

-57.15

-45.97

-5.72

3.78

Russell 3000

-21.04

-43.45

-55.45

-20.19

-14.72

Russell 3000 Growth

-23.27 -61.46

-51.16

-18.47

-13.13

Russell 3000 Value

-18.64 -19.62

-59.77

-21.87

-16.33

Blue

: Best-performing sector/style.

Purple

: Worst-performing sector/style.

–