David Herro Market Commentary | 3Q11 — Summary & Takeaways · Oakmark Funds

Theme and Background

This chapter discusses the similarities between current market volatility and the 2008-2009 period, but the core concern has shifted from private debt to public debt, particularly the sovereign debt issues of eurozone peripheral countries (Greece, Italy, Spain, France). Market sentiment is extremely pessimistic due to global political deadlock and the debt crisis, leading to a sharp decline in international equities.

Core View

The author believes the market has overreacted to the sovereign debt crisis, especially in pricing the default risk of countries like Italy and Spain too high. Despite insufficient political leadership, fundamental data (such as household debt levels, savings rates, and budget balance targets) do not support the extreme scenario of widespread defaults. The disconnect between market sentiment and real economic performance presents buying opportunities for long-term investors.

Key Arguments and Data

Market Overreaction: The market has priced the default probability of Italian five-year bonds at about 5%, but the author considers this "almost absurd."
Italy's Solid Fundamentals:
Household debt accounts for only 65% of disposable income, well below the eurozone average (98%) and the U.S. (148%).
The total savings rate is 12.1%, double that of the U.S.
The budget is expected to be balanced by 2013, and the government holds a large amount of sellable assets.
Solid Real Economy Performance: Despite market turmoil, BMW's global sales hit a record high in August; the IMF expects global economic growth of 4% for both 2011 and 2012.
Oversold European Financial Stocks: Since early August, many European financial stocks have fallen over 30%, but the author argues that market sentiment does not align with economic reality.

Indicator	Italy	Eurozone Average	U.S.
Household Debt/Disposable Income	65%	98%	148%
Total Savings Rate	12.1%	—	~6%
Budget Balance Target	2013	—	—

Companies/Assets Involved

European Financial Stocks (not specifically named): Down over 30% since early August; the author has used the decline to increase holdings in quality financial stocks and is bullish.
BMW: Global sales hit a record high in August, cited as evidence that the real economy has not slowed significantly; bullish.
Emerging Market Countries: Sustained growth is a key support for the global economy; no specific companies named, but implicitly bullish.

Investment Implications

Contrarian Buying: During market panic, take advantage of oversold opportunities to increase holdings in European financial stocks with solid fundamentals.
Focus on Real Economy, Not Sentiment: Global growth is still expected at 4%, and corporate earnings have not seen severe declines; long-term investors should ignore short-term macro noise.
Be Wary of Political Risk but Not Overly Pessimistic: European political leadership is indeed lacking, but the market's pricing of default probabilities has deviated from fundamentals, presenting mispricing opportunities.