Value Added


4 Plays for Contrarian Investors

Steven Goldberg

David Herro, one of the best fund managers specializing in foreign stocks, shares his surprising views on Europe, gold, emerging markets and Japan.



Worried about Europe? The headlines are filled with concerns that Ireland, Spain or some other European country is about to blow up. But to David Herro, who has been investing for a living since 1986 and has delivered terrific results managing Oakmark International Fund (symbol OAKIX) since its 1992 launch, those fears lead to opportunities.

Herro, 50, is a card-carrying contrarian. In addition to being optimistic about Europe, he’s bearish on gold and emerging-markets stocks, and he’s bullish on Japan (yes, Japan). Herro is also modestly upbeat about overall world growth. He estimates that global gross domestic product is increasing at a healthy 5% clip, largely because of rapid economic growth in emerging markets.

Herro’s unusual views would be easy to dismiss except for his record of being right far more often than he is wrong. Over the past ten years through November 26, Oakmark International returned an annualized 8.9% -- an average of 5.6 percentage points per year better than the MSCI EAFE index, which tracks stocks in developed foreign markets. That puts the fund in the top 3% among foreign large-company value funds, according to Morningstar.

Oakmark took a big hit in 2008, falling 41% -- a slightly smaller loss than either the EAFE index or the fund’s average peer. But since stock markets around the world bottomed on March 9, 2009, the fund has been on fire, returning 128.4% through November 26.

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Here are Herro's four bold contrarian plays:

Take Advantage of Cheap European Stocks

Yes, Herro says, Europe has problems. Countries there will have to learn to live within their means. Greece will eventually restructure its outstanding debt. Other countries in the southern part of Europe, as well as Ireland, will have to cut their budgets more and sell off public enterprises.

But Europe isn’t monolithic, Herro says. Northern Europe -- including Germany, Scandinavia and Switzerland -- is doing just fine. “Even Eastern Europe is on the mend,” says Herro. Moreover, he says, European stocks are “very cheap.”

Increasingly, companies operate globally, regardless of where they’re based. Even Banco Santander (STD), the giant Spanish bank, which Herro holds, does just one-third of its business in fiscally troubled Spain. In fact, the bank does an equal amount in Mexico and Brazil. Herro also owns shares of Credit Suisse Group (CS), the Swiss banking giant, which earns a lot of money from asset management.

Don't Be Gold's Fool

Gold, in Herro’s view, is in bubble territory. It costs mining companies maybe $250 to $350 to produce an ounce gold. Yet gold closed November 26 at $1,364 an ounce. Herro won’t venture a guess as to when gold will stop going up. But because of gold’s rising price, commercial demand is already declining.

Ease Up on Emerging Markets

Emerging markets sell at only slightly higher valuations than developed markets. And with the big-picture story so promising, investors continue to pour money into developing-markets stocks. The problem, says Herro, remains poor corporate governance. In many developing markets, the government or a single family may own a large stake in a company, and corporate books are opaque.

Many diversified foreign funds have 10%, 20% and even 30% of their assets in emerging markets. Herro has 3%, mainly in two stocks: Grupo Televisa (TV), the Mexican television-broadcasting giant, and South Korea’s Samsung Electronics, which trades on the pink sheets in the U.S. under the symbol SSNLF (volume is minimal, so beware of wide bid-ask spreads if you trade the stock).

Invest in Japan on the Rise

I’ve saved Herro’s most-contrarian bet for last: After a 21-year bear market in which Japan’s Nikkei 225 has plunged from a hair under 40,000 to 10,000, Herro thinks Japan is finally ripe for a turnaround. Japanese companies’ return on equity (a measure of profitability) has risen dramatically, and share prices relative to book value (assets minus liabilities) have fallen sharply. What’s more, Japanese companies are paying out an increasing amount in dividends relative to their profits. “There’s very limited downside in Japan and a very big upside,” says Herro.

Japanese companies were in Asia before those from other developed economies, so they stand to benefit from growth there. Plus, the Japanese government still has stakes in many big private companies. Selling off these stakes could cut the national debt, lighting a fire under the stock market. Some $7 trillion is in the government-owned savings system; the entire Japanese market value is only $3 trillion. Just a trickle of private money into stocks could make a huge difference.

Herro owns Toyota (TM) and Honda (HMC), but his fund’s biggest Japanese position is Daiwa Securities (DSEEY.PK), which trades on the pink sheets. The financial-services company trades at just 0.7 times book value. It sticks to Asia, which Herro considers a plus. “I see it as a cheap conduit into a cheap market,” he says.

Herro sees little danger of a Japan-style “lost decade” in the U.S.: “There are some similarities but far too many differences.” For instance, all of Japan’s debt is held internally, which bottles up growth. The country’s aging population has been an enormous problem, and Japan doesn’t want immigrants. Plus, says Herro, “monetary policy was terrible.”

Steven T. Goldberg (bio) is an investment adviser.



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