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Summer 2012 Market Commentary

Auxier Focus Fund declined in value 0.96% in second quarter 2012. But the Fund weathered the sloppy market far better than Standard & Poor’s 500 stock index (S&P), which lost a corresponding 2.75%.  For the first six months, our low-risk portfolio returned 5.64%, trailing the S&P’s 9.49%. And we continue to handily outpace the market over the long term, returning 125.53% cumulatively since inception (July 1999) versus the S&P’s 23.15%. This 102 percentage point lead illustrates how we endeavor to exploit the power of compounding by aiming to outperform our peers in down markets rather than chasing glamour stocks during upswings.

High structural debt levels in the developed countries of Europe as well as the United States represent stiff headwinds to global economic growth. The 27 nation European block is the largest economy in the world. Our approach has been to seek out bargain priced securities that can endure the most extreme periods of deleveraging and austerity. Absolute debt (both public and private) in developed countries in general is higher today than in 2007, a year before the financial crisis erupted.  Historically, such indebtedness has meant very sluggish growth.

                 Buying Global Reach on the Cheap

Gloomy headlines out of Europe overshadow some exciting fundamental developments emanating from the 1.8 billion member middle class. It is growing by 150 million people a year and represents over $12 trillion in income that will be spent. The Internet is helping to unleash an exciting new spirit. Asia is undergoing the most rapid urbanization in history. For example, while China’s per capita GDP is still low, wages should double over the next five years. Businesses supplying quality food and necessities are growing twice as fast as the economy. This aspiring middle class is hungry for safe, high-quality western products. New trade agreements with Korea and Columbia are opening up markets for such basics. Many of our companies in the Fund have the scale and distribution networks necessary to meet this growing demand.  Indeed, Europe abounds with such “global reach” stocks that are compelling bargains partly due to the region’s mounting debt crisis. Like farmers, we aim to profit by planting in fertile but recently drought-plagued areas that, now hopelessly out of favor, could produce bountiful harvests once rain returns.

Conventional Wisdom Can Also Be Costly

Achieving above average returns requires a strong research effort, rational approach and superior allocation of investors’ capital. There are no shortcuts. Only a select few businesses typically can thrive in a period of harsh austerity and rapid debt reduction. Popular investment mantras like “buy, hold and forget” and “broad diversification” can actually be hazardous. The most extreme example of the dangers of blindly trusting an index has to be the collapse of Japan’s debt-driven economic boom. On December 29, 1989, the Nikkei index of 225 stocks hit a peak close of 38,915.87. By March 10, 2009, the index had dropped 82% to 7054.98. There is no heart or soul in these indexes. They lack pioneering entrepreneurs like Jim Sinegal of Costco or Sam Walton of Wal-Mart to power through the tough times.

Leverage is often overlooked or misperceived. Jim Grant reminds us that, as recently as 2005, interest rates on Greek 30-year government bonds were a scant 20 basis points¹ higher than those on rock-solid German 30-year Bonds. This despite the fact that Greece had been in default over 50% of the time since the early 1800s. The Greek 30-year subsequently lost over 80% of its value by 2011. Today, the California legislature has approved a $100 billion bullet train project even as more and more cities across the state seek bankruptcy protection. Never mind that virtually every company in the vanguard of the great railroad boom of the 1800s, both here and in Britain, had to be reorganized to discharge excessive debts.

All investment classes need to be thoroughly investigated to determine the actual margin of safety. Relying solely on conventional wisdom has historically proved costly. Since 1999, we have witnessed overlapping booms in technology, housing and commodities, with each lasting over 113 months. The public often confused these speculative booms with investments. Now the thundering herd has charged into government bonds. If they only knew that just six countries over the past eight centuries have honored their debt (This Time Is Different: Eight Centuries of Financial Folly by economists Carmen Reinhart and Ken Rogoff). Shrinking purchasing power is hidden short term but lethal long term. In a recent Fortune article, Warren Buffet explained how the US dollar has declined 85% in purchasing power since 1965. It takes $7 dollars today to buy what $1 bought back then.

Unconventional Wisdom From Wealth Creators

It’s often helpful to look back in history to see how exceptional investors reacted when confronted with seemingly insurmountable problems. J. Paul Getty died in 1976 at age 83 with a net worth in excess of $150 billion in today’s dollars. His experience during the Great Depression is a valuable study in how to allocate capital. Some Getty insights:

“I began buying common stocks at the depths of the Depression. Prices were at their lowest, and there weren’t many stock buyers around. Most people with money to invest were unable to see the forest of potential profit for the multitudinous trees of their largely baseless fears. I had confidence in the future of the American economy and realized the shares of many entirely sound companies with fine potentials were selling at a fraction of their true worth.”  

“The seasoned investor buys his stocks when they are priced low, holds them for the long-pull rise and takes in-between dips and slumps in stride,”

“Big profits go to the intelligent, careful, patient investor, not to the reckless and overeager speculator.”

It’s worth noting the same approach Getty espoused is being practiced today by Carlos Slim, the world’s richest man. The Mexican industrialist is capitalizing on the turmoil in Europe by buying undervalued phone stocks. Says Slim: “When hard times hit, you can look at opportunities in a very agile way. Europe is in a good moment.”

Your trust and support is appreciated.

Jeff Auxier