David Herro Market Commentary | 2Q11
June 30, 2011
Results for our two international strategies were mixed over the 90-day period ending June 30, with Oakmark International (OAKIX) outperforming and Oakmark International Small Cap (OAKEX) underperforming their respective benchmarks. (View Oakmark Fund performance here.)
During the quarter the market experienced continued instability, despite falling energy prices and Japan slowly beginning to recover from the March earthquake and tsunami disasters. These were two of the three major areas of concern that existed at the beginning of the quarter. Of course, the dominant factor still plaguing global financial markets is the situation in Greece.
It’s All Greek To Me
With a population of roughly 11 million people, Greece is a tiny country that entered the European monetary union (EMU) in 2001 and adopted the euro the following year. The EMU requires that members not run deficits greater than 3% of GDP, but Greece violated this rule from 2001 to 2006, and it is in violation now as well. Given its sloppy bookkeeping, it is possible that Greece may have never complied with this requirement. Persistent fiscal deficits have saddled Greece with government debt exceeding $400 billion, or at least $40,000 for every man, woman and child. The last Greek budget called for more than $142 billion in spending, while revenues were only projected to be $114 billion.
Greece represents roughly just 2.5% of European GDP. One has to ask how such a small part of the global economic system can cause so much macroeconomic havoc.
The economic system of Greece, similar to many of its European neighbors, features a rather large role for the government. Greece’s public sector represents over 51% of GDP, more than triple that of tourism, the No. 2 industry at 15% of GDP. Private-sector growth is constrained by unclear regulations and tough labor rules. Additionally, tax avoidance and outright tax evasion is rampant.
If Greece were not part of the European Union (EU), we think it would almost certainly default on its debt and have to devalue its currency. The devalued currency would perhaps spur more tourism and maybe attract some industry, but in the end, few would seriously consider investing in Greece unless labor laws were eased and both tax laws and industrial regulations simplified.
To have a chance at recovery, we think the Greek people themselves will have to lose their “I am entitled” attitude. They must work longer (current average retirement age is 61), they must embrace privatization and they must learn to live without so much reliance on government.
This situation will pass, we believe, as all macro storms do, but perhaps there’s a broader lesson here: The state can only help those who cannot help themselves when there is a vibrant economy that provides the means to do so. If the size of the welfare state, and the funds needed to support it, strangle a productive private sector, there won’t be resources available for those most in need. Greece isn’t alone on this score -- other European countries are struggling with these same issues, as are we in the U.S.. None of us is immune to the consequences of spending too much of tomorrow’s tax collections today.
Greece is threatening its EU neighbors and scaring the world, not because of its impact on global GDP growth, but because close to half of Greek debt is held by the European Central Bank and much of the rest is held within the European banking system. We think that none of this “paper” is worth close to 100 cents on the dollar. The Europeans are trying, through the strings attached to their bailout money, to stem the losses and force change to the way Greece operates. They feel this is a better approach than kicking Greece out of the EMU, as that would make the EU susceptible to more of the same and thus weaken its position on the world stage. This likely is a shocking thought to the Eurocrats in Brussels!
We must hope the situation in Greece will prove to be a turning point and that all of us in heavily indebted countries learn to avoid the brink by acting in a fiscally responsible manner.
In the meantime, we do not believe Greece will stop, or even slow, the growth of global prosperity, which not only enhances the environment for profit growth, but also improves living standards around the world. We think a greater danger is posed by the larger economies of the world that are also wrestling with substantial sovereign debt issues. We hope the situation in Greece will serve as a reminder to those in need of change to do so rapidly to avoid truly imperiling global economic prosperity.
David G. Herro, CFA
Investing in foreign securities presents risks that in some ways may be greater than U.S. investments. Those risks include: currency fluctuation; different regulation, accounting standards, trading practices and levels of available information; generally higher transaction costs; and political risks.
The stocks of smaller companies often involve more risk than the stocks of larger companies. Stocks of small companies tend to be more volatile and have a smaller public market than stocks of larger companies. Small companies may have a shorter history of operations than larger companies, may not have as great an ability to raise additional capital and may have a less diversified product line, making them more susceptible to market pressure.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.