Halfway through the quarter, the stock market seemed poised to continue its strong 2019 performance, though at a somewhat muted rate of increase. The S&P 500 was up 3% and the Oakmark Fund hit a new all-time high NAV on February 12, even though growth stocks still dominated over value. We had little portfolio turnover as most of our holdings were selling at prices between our established buy and sell targets. Then, the bottom fell out. From February 20 through March 23, the S&P 500 declined 34%, the fastest drop of that magnitude in history.
At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.
The expected downturn in GDP, which many thought was overdue, will not occur because of excesses in the economy, but because of a voluntary shutdown to avoid a worst-case death toll from the coronavirus pandemic, COVID-19. A new vocabulary quickly emerged, including terms like “flatten the curve,” “social distancing” and “shelter in place.” Epidemiologists became TV stars, tourism stopped on a dime, schools were closed, workers were told to stay home, the oil market collapsed, corporate bond spreads exploded and investors grew more worried about the banking system than they had been since 2008. Our Funds performed poorly in both absolute and relative terms as the companies we thought were cheapest before the decline tended to be those that were viewed as benefitting the most from a continued strong economy.
We were unusually active in the second half of the quarter. We believe that extreme market volatility allowed us to increase the fundamental attractiveness of our portfolio. We were able to buy stocks in companies we believed offered greater undervaluation, higher quality or stronger balance sheets (and, in some cases, offered all three) than the companies we were selling. When markets make such extreme moves, desperate investors who need cash have to sell, and those with cash are able to buy— in contrast to normal conditions when trades tend to occur because investors have different time horizons or opinions on a stock’s long-term value. In the past quarter, we often purchased from desperate sellers, using assets from our cash reserves or from selling off some of our holdings that had performed relatively well. To highlight the opportunities available: typically, we at Oakmark buy stocks priced at less than 60% of our estimate of business value and sell them when their price exceeds 90% of that value. During the past few weeks, we were selling stocks priced at 60% or more of our estimate of business value and buying companies priced at less than 40%. To us, these are incredibly compelling opportunities.
Amidst this turmoil, the financial media has been full of speculation as to whether or not the stock market bottom has been reached. We don’t believe anyone knows and we know that we don’t know either. Earlier this month, we wrote a note reminding Oakmark shareholders that we don’t consider market timing to be a skill of ours, so instead we consistently encourage portfolio rebalancing. Today, that likely means selling assets that have performed well, like Treasury bonds, and using the proceeds to buy assets that have underperformed, like stocks. That restores the portfolio balance that existed prior to the stock market’s downturn. In our personal accounts, most of the Oakmark portfolio managers bought more of the Oakmark Funds to rebalance our own investments.
As we look to the new quarter, we anticipate that our trading activity will remain at an elevated level as we continue to adjust to changing stock prices and capture the tax losses created by the downturn. We will also look even more closely at the management teams running our companies. We only invest in those companies that we believe are being managed to maximize long-term business value per share. We will evaluate what our companies accomplish during this downturn and revise our management quality ratings accordingly.
When we look back to 2008, some companies completed strategic acquisitions that were only possible because of the financial crisis: Wells Fargo purchased Wachovia, Liberty Media bought Sirius XM, Comcast bought NBC Universal and Berkshire Hathaway bought Burlington Northern. In hindsight, each of these added significantly to the acquirer’s per share value. Other companies, such as Netflix, took advantage of their own depressed share price to reduce the number of shares outstanding, increasing each remaining share’s percentage ownership. From late 2007 through 2010, Netflix repurchased 27% of its outstanding shares at an average price of $6 per share. Netflix today is priced at $372 per share, more than 60 times the repurchase price. We have no doubt that many of our companies will be looking for the value-enhancing opportunities created by this economic downturn.
On a final note, I want to express my thanks to the Harris Associates IT team. We’ve never been a work-from-home firm, believing that the corporate culture we so jealously guard would be eroded without the shared experience of being in the office together. Despite that, to protect our employees and our investors, we went to a work-from-home mandate a week before the city of Chicago did. It was no small task to make sure that all of our 200 employees could seamlessly communicate with each other, that our many data feeds were fully accessible and that we could execute the increased trading volume that we expected in a high volatility environment. It went off without a hitch.
Our analyst group has remained connected via daily group chats and weekly Zoom happy hours. With virtual meetings, we have maintained our tradition of sharing great lunchtime conversations as a team. It isn’t perfect, so don’t expect us to ever be one of those firms that works primarily from home. But given what I’ve heard from friends at other investment firms, we’ve been able to maintain our usual routines better than most. And to all my colleagues at Harris Associates, if nothing else positive comes from this, working from home has made me extremely grateful for the wonderful bunch of people I typically get to see every day. I miss you all and look forward to the day we can be back in the office together.
We are hopeful that three months from now, when you read our second-quarter commentary, the Cubs will be playing baseball, we will be eating inside of restaurants and we will all be rescheduling the trips we’ve had to cancel. If that has happened, we believe the economy will likely recover quickly as will the stock market. But if it takes longer to return to normal, know that we have weighted our portfolios toward companies that we believe can survive a longer downturn and that we fully expect can emerge stronger on the other side.
The securities mentioned above comprise the following preliminary percentages of the Oakmark Fund’s total net assets as of 03/31/20: Berkshire Hathaway 0%, Comcast Cl A 3.1%, Liberty Media 0%, Netflix 3.4%, Sirius XM 0%, Wells Fargo 1.8% and Zoom 0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.
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 by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.
The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change and may change based on market and other conditions and without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.
Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.
All information provided is as of 03/31/2020 unless otherwise specified.