Bill Nygren Market Commentary | 2Q22

Theme and Background

This chapter discusses how to maintain a long-term investment perspective amid the harsh market and economic conditions of the second quarter of 2022. The core backdrop is that the S&P 500 fell 21.8% from its January 3 high, entering a bear market, and real GDP contracted by 1.4% in the first quarter as inflation reached 8.1%, leading to extremely pessimistic market sentiment.

Core Thesis

The author argues that investors should not panic-adjust their portfolios in response to bear markets, recessions, or high inflation. Historical data shows that after these negative events, the medium-term returns on stocks are not lower than those from random purchases, and are in fact often higher. The counterintuitive finding is: the median return two years after a bear market's first 20% decline is 33%, significantly higher than the 17% from random purchases; the median return two years after the start of a recession is 25%, also above the random level; and the two-year return after high inflation (>8%) is on par with random purchases at 17%.

Key Arguments and Data

• Bear Market: Since 1945, the S&P 500 has experienced 12 bear markets. After the first 20% decline, the median bottom occurred 117 days later, with a median additional decline of 10%. However, the median two-year return was 33%, compared to just 17% for random purchases over the same period.
• Recession: Since 1945, there have been 12 recessions. The median two-year return for the S&P 500 after the start of a recession was 25%, with only one instance being negative. The corresponding return for random purchases was 17%.
• Inflation: Since 1945, there have been only five periods with inflation exceeding 8%. The median two-year return for the S&P 500 after inflation topped 8% was 17%, matching the return from random purchases.
• Current Bank Stock Valuations: The author's bank holdings trade at a forward P/E of just 4-8x, compared to 15x for the S&P 500.

Event Type	Median Two-Year Return After Event	Two-Year Return from Random Purchase	Number of Historical Occurrences
Bear Market (first 20% decline)	33%	17%	11 (first 11 instances)
Recession Start	25%	17%	12
Inflation >8%	17%	17%	5

Companies/Assets Involved

• Bank of America: Mentioned as a representative bank stock. Its tangible equity ratio under a high-stress scenario is higher than before the Great Recession, indicating ample capital.
• Netflix: Cited as an example of "company-specific disappointment," but no further analysis is provided.
• Energy Companies: The author believes energy companies in their portfolio can benefit from high oil prices.
• Bank Stocks (Overall): The author is bullish, arguing that current valuations are extremely low (4-8x forward P/E), banks are well-capitalized, lending standards have not loosened, and scale economies are evident—contrary to widespread market pessimism.

Investment Implications

• Do Not Try to Time the Market: Historical returns after bear markets, recessions, and high inflation are not poor; the market has already priced in negative information, making post-hoc adjustments too late.
• Stick with Dollar-Cost Averaging and Rebalancing: The author recommends using dollar-cost averaging for new funds and rebalancing portfolios after significant market swings.
• Focus on Low-Valuation, Short-Duration Assets: The author's portfolio has a P/E significantly below the S&P 500, implying a shorter "duration" and less impact from rising interest rates; bank and energy stocks benefit relatively in a high-inflation environment.

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Theme and Background

This chapter discusses the current portfolio composition of the Oakmark Fund and the specific application of value investing principles in the current market environment. The report refutes the market's stereotype that value investors should only hold "low-growth, high-dividend" traditional industries and explains why the portfolio holds no utility stocks, instead heavily weighting technology stocks perceived as "growth" names.

Core Thesis

The report's core investment argument is: Value investing should not be equated with investing in low-quality companies, but rather with buying any high-quality company when it trades at a significant discount. Currently, high-growth companies like Alphabet, Booking, Meta, and Netflix have valuations (P/E ratios) that are actually lower than those of mediocre utility stocks, presenting an attractive opportunity for value investors.

The counterintuitive judgment is: The market generally believes value investing should avoid "growth" technology stocks, but the report argues that when these technology stocks are cheaper than utility stocks, it is irrational not to buy them.

Key Arguments and Data

The report supports its view by comparing valuation data:

1. Utility Stocks Are Not Cheap: The average electric utility stock has a price-to-earnings ratio (P/E, based on consensus 2023 earnings, adjusted for cash) of 16.7x.

2. Oakmark Portfolio Valuation Is Lower: Among the 55 stocks held by Oakmark, only 10 have a P/E ratio above 16.7x. Twenty holdings have single-digit P/E ratios, and the median P/E ratio of the portfolio is only 12x cash earnings.

3. Growth Stocks Trade Below Utilities: The report lists four holdings considered "too growthy," all with P/E ratios below the average for utilities.

Company/Asset	P/E Ratio	Notes
Average Electric Utility Stock	16.7x	Used as a comparison benchmark
Oakmark Portfolio Median	12x	Below utilities
Alphabet	Below 16.7x	Specific figure not given, but explicitly below utilities
Booking	Below 16.7x	Specific figure not given, but explicitly below utilities
Meta	Below 16.7x	Specific figure not given, but explicitly below utilities
Netflix	Below 16.7x	Specific figure not given, but explicitly below utilities

Note: The P/E ratio used in the report is defined as: subtracting net cash from the stock price, then dividing by earnings per share after adding back intangible asset amortization.

Companies/Assets Involved

• Alphabet (GOOGL): Accounts for 3.1%, 10.2%, and 12.0% of the Oakmark Fund, Oakmark Select Fund, and Oakmark Global Select Fund, respectively. The report argues its valuation is below that of utility stocks, making it a good value investment target.
• Booking Holdings (BKNG): Accounts for 1.5%, 3.1%, and 2.7% of the three funds, respectively. Also viewed as an undervalued growth stock.
• Meta Platforms (META): Accounts for 2.4%, 4.6%, and 0% of the three funds, respectively. The report considers its valuation attractive.
• Netflix (NFLX): Accounts for 2.1%, 4.8%, and 2.5% of the three funds, respectively. Listed as a growth stock trading below utility valuations.
• Bank of America (BAC): Accounts for 1.5% and 4.2% of the Oakmark Fund and Oakmark Select Fund, respectively, and 3.1% of the Oakmark Global Select Fund. Mentioned as a value stock in the portfolio, but not analyzed in detail in this chapter.

Investment Implications

For investors, the report's takeaway is: Do not be misled by the market's labels of "value" and "growth." In the current environment, some high-quality, high-growth technology companies are mispriced due to market panic, with valuations even lower than traditionally "cheap" utility stocks. Investors should use market volatility and price declines as opportunities to reallocate cash into these undervalued, high-quality assets. The report quotes Warren Buffett, encouraging investors to remain calm and buy counter-cyclically during bear markets.