David Herro Market Commentary | 4Q16
December 31, 2016
Despite a year that opened extremely weak and could be defined as one which had sharp downward price movements throughout the year, our international and global investment strategies were able to increase value. For the fourth quarter of 2016, both the Oakmark International Fund and the Oakmark International Small Cap Fund built on the strong absolute and relative performance of the third quarter. Please see individual Fund letters for details on performance.
Conventional Wisdom is Often Incorrect
Going into 2016, our international and global strategies were generally overweight where we found value, particularly with stocks in the financials, industrials, consumer discretionary and materials sectors. We were tremendously underweight in the sectors that were viewed as “safe,” such as utilities and consumer staples. We were positioned as such because of valuation differentials. For example, many of the financial stocks in our portfolios were selling at single-digit P/E ratios and below their book value.
Because of low/negative interest rates and increasing loan losses in the energy sector, conventional wisdom and many pundits believed that earnings of these companies would be decimated. In fact, there was no wide-spread earnings destruction at all, and because various banks and financials were able to grow their loan books, cut expenses and increase fees, some earnings growth occurred.
We believed that the market would eventually re-price financial businesses once it became quite clear that earnings in this sector were far more resilient than feared. And they did.
It is important to note that simultaneously, the U.S. Federal Reserve began to increase interest rates, which provided better lending spreads and an additional boost to the income statements of commercial banks.
It is Possible to OVERPAY for Insurance
When one considers the valuation spread between the consumer discretionary and industrials sectors versus consumer staples, it was obvious to us that investors were over-paying for perceived safety. Daimler, a vehicle manufacturer, offers one example. At one point during the year, Daimler traded at just over seven times forward earnings (one year out) with a well-covered 5+% dividend yield. This compared to some companies in the consumer staples sector that traded at over 20 times forward earnings.
From a fundamental value perspective, the valuation spread between the various types of businesses was just too large and presented an exploitable investment opportunity. As value investors, this is our key task: to focus on the fundamental drivers of long-term cash flows and see through the haze generated by market pundits, who are overly influenced by geopolitical events such as referendums and other elections. We seek to advantage our shareholders by making investment decisions based on a company’s ability to generate and sustain a growing cash flow, as opposed to looking for “safe” stocks.
Our view is that these types of macro events continually move share prices. There is never a break from them. We strive to seize opportunities when prices move far greater than our estimate of intrinsic value, which is often the case and was very evident in 2016.
Wishing Our Clients a GREAT 2017!
Last year required an inordinate amount of patience and discipline. I would like to thank all of our clients for generally granting us these two virtues throughout the year. Hopefully this year will deliver similar results without all of the flare. We will continue to do our best to deliver acceptable results. Happy 2017!
David G. Herro, CFA
View other commentary and letters from David here.
The securities mentioned above comprise the following percentages of the Oakmark International Fund’s total net assets as of 12/31/16: Daimler AG 3.3%.
The securities mentioned above comprise the following percentages of the Oakmark International Small Cap Select Fund’s total net assets as 12/31/16: Daimler AG 0%.
Click here to access the full list of holdings for The Oakmark International Fund as of the most recent quarter-end.
Click here to access the full list of holdings for The Oakmark International Small Cap Fund as of the most recent quarter-end.
Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The Price-Earnings Ratio (“P/E”) is the most common measure of the expensiveness of a stock.
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.
Oakmark International Small Cap Fund: 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.
Oakmark International and Oakmark International Small Cap Funds: The Funds’ portfolios tend to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held will have a greater impact on the Funds’ net asset value than it would if the Funds invest in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Funds’ volatility.
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.