Theme and Background
This chapter discusses the market's overuse of the term "unprecedented" and its impact on investor psychology, while outlining Oakmark's long-term investment framework amid extreme market volatility. The report notes that in the second quarter of 2020, the market experienced the fastest bear market in history (the S&P 500 fell 34% in 23 trading days) and the fastest rebound (rising 40% in 50 days). However, a 40% gain cannot offset a 34% decline (0.66 × 1.40 = 0.92), leaving the index still below its level at the start of the year.
Core Views
- The term "unprecedented" is overused, exacerbating unnecessary investor anxiety: Approximately 75% of companies used the term in their quarterly conference calls (IBM used it seven times). Oakmark believes this serves as an excuse for management to miss expectations rather than reflecting genuine changes in economic fundamentals.
- Market volatility should serve as a rebalancing signal, not a calendar: The report advises investors to rebalance their portfolios based on significant market swings (rather than fixed time intervals), given the extreme speed of both declines and rebounds.
- "Value" and "growth" are not opposites: Oakmark defines value investing as buying stocks at prices well below their intrinsic value, regardless of their price-to-earnings ratios or growth rates. Currently, high-growth companies (such as Alphabet and Facebook) and low-growth banks (such as Citigroup and Capital One) are both considered "value stocks."
- Bank stocks are currently highly attractive in valuation: Although a historical price-to-earnings discount has existed, the current discount for bank stocks far exceeds the historical average, and business quality has improved due to economies of scale and technology investments.
Key Arguments and Data
- Market volatility data:
- The S&P 500 fell 34% in 23 trading days, then rebounded 40% in 50 days.
- A 40% gain cannot offset a 34% decline: 0.66 × 1.40 = 0.92, leaving the index still below its level at the start of the year.
- Frequency of "unprecedented" usage: Approximately 75% of companies used the term in their quarterly conference calls, with IBM using it seven times.
- Economic recovery scenario: Oakmark adopts a "checkmark-shaped" forecast—recovery begins in the second half of 2020, with GDP exceeding 2019 levels by 2022. The core of intrinsic value lies in long-term discounted cash flows, not the precise timing of GDP recovery.
- Bank stock valuation comparison:
| Metric |
Bank Stocks (Holdings) |
S&P 500 |
| 2021 Expected P/E Ratio |
9x |
19x |
| P/E Discount Magnitude |
53% (needs to rise 40% to return to historical average discount) |
— |
| Historical Average P/E Discount (30 years) |
Approximately 33% |
— |
- Improvement in bank stock business quality: Economies of scale (online banking, fraud protection, compliance, technology) bring cost advantages; higher equity ratios reduce risk; in a low-interest-rate environment, spreads on mortgages, auto loans, and credit cards have widened due to falling Treasury yields, offsetting interest income losses.
Companies/Assets Involved
- Alphabet (GOOGL): Considered a "value stock," currently cheap in valuation despite a P/E ratio above the market average.
- Facebook (FB): Similarly, high growth but priced below Oakmark's estimate of intrinsic value.
- Citigroup (C): A representative bank stock, with a P/E ratio far below the market average and a current discount of 53%.
- Capital One (COF): Another representative bank stock, similarly undervalued, with a P/E ratio roughly half that of the S&P 500.
- IBM: Used the term "unprecedented" seven times in its conference call, cited by the report as a typical example of overusing the term.
Investment Implications
- Investors should avoid being swayed by emotional terms like "unprecedented" and focus on intrinsic value assessments based on long-term discounted cash flows.
- The current valuation of the S&P 500 is roughly reasonable, but individual stocks held by Oakmark (especially bank stocks) remain significantly undervalued. Bank stocks would need to rise by approximately 40% to return to their historical average P/E discount level.
- The revival of traditional value investing may generate excess returns: On days when the Russell 1000 Value Index outperforms the S&P 500, the Oakmark and Oakmark Select funds have outperformed both more than 80% of the time.
- Concerns about low interest rates for bank stocks are overpriced: Banks have already offset interest income losses through fee income and spread widening, and improved business quality makes the historical P/E discount no longer justified. The current discount (53%) far exceeds the historical average (33%), providing a margin of safety.
Theme and Background
This chapter summarizes the Oakmark second-quarter 2020 report. The report notes that while overall market valuations have become roughly reasonable, the prospects for value investing and economic recovery remain undervalued. It uses fund performance data to illustrate Oakmark funds' relative short-term performance and emphasizes the potential value of its portfolio.
Core Thesis
The author argues that current market pricing is broadly reasonable, but expectations for an economic recovery and the return of value investing have not yet been fully priced in. Oakmark's portfolio remains significantly undervalued and is well-positioned for both recoveries. This is a contrarian view: while most investors worry about uncertainty, Oakmark sees systematic undervaluation opportunities in value stocks.
Key Arguments and Data
- Market Pricing: The report considers the S&P 500's valuation reasonable but does not provide a specific valuation multiple.
- Fund Performance Comparison: Oakmark funds show mixed performance over 3-month and 1-year periods but underperform the S&P 500 over the long term (5-year, 10-year) while outperforming the Russell 1000 Value Index.
- Expense Ratios: OAKMX net expense ratio is 0.88%, and OAKLX net expense ratio is 1.00%, both below the industry average.
| Fund/Index |
3-Month |
1-Year |
3-Year |
5-Year |
10-Year |
Since Inception |
| OAKMX |
23.01% |
-6.67% |
2.06% |
5.55% |
11.33% |
11.65% |
| S&P 500 |
20.54% |
7.51% |
10.73% |
10.73% |
13.99% |
9.71% |
| Russell 1000 Value |
14.29% |
-8.84% |
1.82% |
4.64% |
10.41% |
9.24% |
| Fund/Index |
3-Month |
1-Year |
3-Year |
5-Year |
10-Year |
Since Inception |
| OAKLX |
23.26% |
-10.48% |
-4.18% |
0.74% |
8.98% |
10.44% |
| S&P 500 |
20.54% |
7.51% |
10.73% |
10.73% |
13.99% |
8.50% |
| Russell 1000 Value |
14.29% |
-8.84% |
1.82% |
4.64% |
10.41% |
7.71% |
Companies/Assets Involved
- OAKMX (Oakmark Fund): Launched in 1991, net expense ratio 0.88%. Outperformed the S&P 500 and Russell 1000 Value in the short term (3 months) but underperformed the S&P 500 over 1-year, 3-year, 5-year, and 10-year periods. The author is bullish on its long-term value recovery potential.
- OAKLX (Oakmark Select Fund): Launched in 1996, net expense ratio 1.00%. Outperformed both indices over 3 months but underperformed the S&P 500 over 1-year, 3-year, 5-year, and 10-year periods, with a negative 3-year annualized return (-4.18%). The author believes its current undervaluation is greater, offering stronger recovery elasticity.
- S&P 500 Total Return Index: Used as a benchmark, with a 1-year return of 7.51% and a 10-year annualized return of 13.99%, showing strong performance.
- Russell 1000 Value Index: Used as a value stock benchmark, with a 1-year return of -8.84% and a 10-year annualized return of 10.41%, significantly underperforming the S&P 500, highlighting the prolonged downturn in value stocks.
Investment Implications
- Directional Judgment: Investors should increase allocation to value stocks, particularly deep-value holdings in Oakmark's portfolio. The current pessimistic pricing of value stocks offers a contrarian buying opportunity.
- Time Horizon: Value stocks have lagged in the short term (1 year), but the report suggests that an economic recovery (with GDP expected to recover by 2022) will drive a value rebound. Investors should hold for 3-5 years to realize gains.
- Risk Warning: If the economic recovery falls short (e.g., a "checkmark" scenario fails), value stocks may continue to face pressure. However, the report argues that long-term discounted cash flows are the core of intrinsic value, and short-term volatility does not alter the undervaluation conclusion.