• Bill Bullock

2012 Second Quarter

Unfortunately, the first quarter gains never stuck like we wanted them to. We have Europe to thank for that. The month of May was dreadful for our stock funds; however, we have had a bit of a recovery in June. Moreover, our fixed income holdings had a solid first half, which your quarter-end reports will indicate. I would like to spend the majority of this letter discussing some of my thoughts on our foreign investments and why they remain pertinent to our overall portfolio management strategy.


I am under the opinion that Europe will be a mess for a while so we might as well begin getting use to it. That is unless Germany steps up to the table and works out a deal with their Euro-partners where they share in the debt (EuroBonds?) for more control over each country's finances. The other alternative is to start kicking countries like Greece out of the Euro, which no one wants to do. Too many banks around Europe own a lot of Greek bonds and booting Greece out of the Euro would essentially bankrupt Greece to the point that depositors would want to withdraw any savings they have out of the European banks holding Greek debt. It would not be pretty. While May was a poor month for equity returns, things started to turn around a bit in June. The Greek election that saw a Euro-friendly government elected proved to be the catalyst for the June stock market rally. This election result obviously increased the chances that Greece will remain in the Euro.


A friend of mine was after me to read Boomerang: Travels in the New Third World by Michael Lewis earlier this year. Mr. Lewis is known for his books The Blind Side and Moneyball, which became hit movies, as well as a book called The Big Short, which was widely regarded as one of the better books describing the cause and effect of the real estate bubble in the late 2000's. I finally started Boomerang several weeks ago and have found it pretty disturbing.


In Boomerang Mr. Lewis describes that in Greece males could retire from their jobs with full benefits at the age of 55 while females could retire at the age of 50. In order for you to retire upon reaching 55 and 50, however, your job had to be classified as "arduous." According to Mr. Lewis, this labeling was done by government officials who could easily be persuaded for the right amount of cash. So one of the results ended up being that if you are a female hairdresser in Greece and you reach the age of 50, you would be able to retire from your job with full benefits. Greek politicians were also known to tell the tax collectors during election years to "disappear." Thus, tax revenue severely declined during election years. When the government finally wanted to write down all of their debts in 2009, the list grew by the day as more and more staffers continued to find unaccounted for debt. Crazy stuff, isn't it? Greece was one example of many. Iceland, Ireland and Germany are also discussed.


I do not know what the new retirement age is in Greece. I am sure that some of these issues have been addressed, but many more will surface in the next few years - if not from Greece then from other areas within the global economy. While experts have labeled this process as "global deleveraging" in the past, I would like to think that this is simply a product of the continued reconciliation of one country's (e.g. Greece, Spain, Portugal) economy to the new global economy that prefers solid foundations on which to build. All of this begs the question: Why would one want to invest in foreign stocks or bonds given that the above problems could take years if not decades to resolve?


There are many solid, global companies that happen to be headquartered in Europe that are being sold or avoided along with the rest of Europe due to the humongous problems mentioned above. It is our mutual fund managers who always have an ear to the ground that will hopefully find these global companies and buy them cheaply.


That said, diversification will play an even greater role going forward. Obviously, you would want to own many companies instead of a few in case one or two have difficulties or file for bankruptcy. Just as important, the large-cap companies you own must have a diversified global sales presence. For example, if Nestle is solely dependent upon Switzerland or even Europe for their sales, they will post disappointing sales results if Europe continues to slow down. As it happens, Nestle only has 3% of their sales within Switzerland - the rest of their sales are global. It is up to our mutual fund managers to find firms such as Nestle and place them in our portfolios. When the "baby is thrown out with the bath water," as was the case with European stocks in the month of May, opportunities for our fund managers increase.


Currently, your foreign stock weightings are 20% of your total equity weightings. This would make your foreign holdings 12% in a 60% stock and 40% fixed income portfolio. I am comfortable with this allocation for the time being. The three foreign equity mutual funds we are using, Third Avenue Value, First Eagle Overseas and IVA International Equity are all known for their deep value disciplines. Let's hope the recent market turmoil will prove to be a bonus for our portfolios.

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