In the past two years, as the world economy has worked to shake off the doldrums of global economic crisis, investors willing to take big risks coming out of the slump have won handsome rewards in many investment categories.
"The stocks that in general performed the best over the last year and three-quarters have been companies that you think perhaps are riskier," says Bob Wyckoff, a partner/owner at asset management firm Tweedy Browne.
Financial companies, for instance, had a tremendous bounce from their bottom in 2009. So did media stocks. Small caps outperformed large caps. Emerging markets performed better than their developed market brethren. Leveraged businesses did better than unleveraged ones, he says.
But if people have been rewarded for higher risk-taking in the last couple of years, jumping into growth off a bounce, might they be rewarded for seeking value in the years ahead?
It's hard to say exactly what will happen next. People already thought small caps were primed for a downturn last year, so high their valuations had risen. So it's understandable people still think that small caps and mid-caps, which have outperformed in the last couple of years, may now have to take a back seat to large-cap blue chip stocks, which everybody roundly believes are very cheap. Others say that emerging markets, which have been hogging the spotlight, have left in the shadows a lot of sweet developed market bargains.
Many blue chip stocks continue to be unfairly priced for slumps even as their earnings increase. Bill Miller, the CIO of Legg Mason, said in the Financial Times in September that large-cap stocks were the bargains of a lifetime and hadn't been this cheap next to bonds since 1951.
Some quality large-cap companies sell for less than 14 or 15 times trailing earnings, cheaper than they have been since the financial crisis and before that in over a decade, says Adriana Posada, a co-manager of the American Beacon Large Cap Value Fund, a four-star portfolio with Morningstar. Posada agrees with Miller that the outlook for large-caps is indeed good.
In 2010, the underperformance of large caps was more than 10% relative to small caps as measured by the Russell indices, she says. The problem is that when large caps suffered their lost decade, many investors turned away from them, fleeing to quality in Treasurys perhaps, and large company valuations plummeted. That has now made them cheap, attractive buys.
And yet, in the meantime, Posada says, "many multinationals have improved their businesses and continued operating successfully during the recent recession, continued to grow, increased earnings and many have been paying a dividend yield above Treasurys and investment-grade debt yields." They've increased their dividends to boot, she says. And large-cap investors will further benefit as the economy picks up.
Michael R. Keller, portfolio manager of the BBH Core Select Fund at Brown Brothers Harriman & Co. Investment Management, says: "It is indeed the case from what we've seen that large cap looks cheaper than small cap at this point. But in our view, it always has to be filtered through where the growth opportunities are in those areas, where is your capital going to be protected, where are you going to have greater visibility into the quality of the businesses over a long period of time? And for our purposes, large-cap quality companies tend to fit more along those lines where we have a greater visibility into the 10- to 15-year type of outlook."