Oakmark is the mutual fund family launched in 1991 by Harris Associates, the Chicago deep-value firm founded in 1976 (about $105bn AUM). Bill Nygren runs the flagship Oakmark Fund and David Herro the Oakmark International Fund, buying businesses at large discounts to intrinsic value and holding them like owners — publishing quarterly fund commentaries, market commentaries and insight articles.
This is a letter from Oakmark fund manager David Herro to investors at the end of 2011. Global stocks had a terrible year due to Japan's tsunami, Thailand floods, and Europe's debt crisis. But Herro argues this is a great buying opportunity. He points out that Japanese and European financial stocks are extremely cheap—some banks trade below half their book value (assets minus liabilities) yet remain profitable. Meanwhile, U.S. and Japanese government bonds yield less than 2%, which he says is unsustainable. Over the long run, stocks will outperform bonds. He also believes the eurozone will survive and strengthen. The message: don't panic; cheap stocks now mean big gains later.
An Oakmark research article notes that while international funds and international small-cap funds performed reasonably well in the fourth quarter of 2011, global stock markets underperformed for the full year due to natural disasters in Japan and Thailand as well as the European sovereign debt cris
This chapter focuses on the performance of the Oakmark International and International Small Cap Funds in 2011, a year when global stock markets underperformed due to natural disasters in Japan and Thailand and the European sovereign debt crisis. The author, David Herro (portfolio manager of the Oakmark International Fund), acknowledges short-term challenges while maintaining strong confidence in the medium- to long-term outlook, systematically articulating his value investing logic.
The author's core investment argument is that despite short-term market volatility, current valuations of global equities—particularly Japanese and European financial stocks—are at extreme lows. Combined with still-acceptable global economic growth rates and unsustainable yields on "safe assets," medium- to long-term stock returns will significantly outperform bonds. Counterintuitive judgments include: 1) European financial stocks are not uniformly distressed; there are healthy, well-capitalized, and profitable companies; 2) the eurozone will not only avoid disintegration but will strengthen integration; 3) the root cause of Southern Europe's problems is not insufficient tax revenue, but oversized government and rigid microeconomic policies.
1. Extremely Low Valuations
As of the end of November 2011, valuation metrics for the EAFE Index and Japanese equities were as follows:
| Metric | EAFE Index | Japanese Equities |
|---|---|---|
| Price-to-Book Ratio | 1.3x | 0.9x |
| Price-to-Cash Flow Ratio | 6.7x | 5.7x |
| Dividend Yield | 3.9% | 2.7% |
| 10-Year Government Bond Yield | — | 0.96% (January 3, 2012) |
The author emphasizes that Japanese manufacturing, after suffering the dual blows of the earthquake/tsunami and Thai floods, is poised for a V-shaped economic recovery. Among European financial stocks, some companies trade at less than half their book value while remaining profitable.
2. Global Economy Still Growing
Although parts of Europe are in recession, the U.S. economy is accelerating, and growth in Asia (including Japan) is significant. The IMF projected 4% global economic growth for 2012 in September 2011. Low valuations combined with economic growth typically bode well for stock prices.
3. Unsustainable Bond Yields
The U.S. 10-year Treasury yield is below 2%, the 5-year yield below 1%; Japan's 10-year yield is below 1%. Bonds have outperformed stocks over the past 30 years, but the author believes this excess return is unsustainable, and mean reversion will drive capital from bonds to stocks.