The Thomas White American Opportunities Fund primarily invests in equity securities of mid-size U.S. companies. The Fund may also invest in equity securities of smaller and larger size U.S. companies.
Fund Manager Commentary
September 30, 2011
U.S. equity prices weakened during the third quarter of 2011, but managed to outperform most other developed markets. The review period was marked by protracted political debates addressing long-term fiscal challenges and the downgrade of the country’s sovereign AAA credit rating. Second quarter Gross Domestic Product growth registered below expectations, even after the latest upward revision. The lack of a concerted effort by the big European economies, the European Central Bank, and the International Monetary Fund to reign in the Euro-zone financial crisis also cast a shadow on market sentiment. Not surprisingly, treasury bonds outperformed stocks, as fears of a renewed downturn and growing financial systemic risks played on the minds of investors.
The Thomas White American Opportunities Fund returned -17.78% for the quarter ended September 30, 2011, compared to the Fund’s primary benchmark, the Russell Midcap Index, which returned -18.89%. The Fund’s secondary benchmark, the S&P 500 Index, returned -13.86% for the same period. For the trailing 1-year period, the Fund returned -1.91% against -0.88% for the primary benchmark and +1.15% for the secondary benchmark.
The political schism over ways to contain the fiscal deficit and public debt has widened in recent months, as both sides strive to mark out ideologically distinct approaches ahead of the 2012 presidential election. The debate over raising the federal debt limit went down to the wire early in the quarter, before a last minute deal averted a debt default and government shutdown. The downgrading of the U.S. debt by rating agency Standard and Poor’s added to the intensity of budget and fiscal debates.
The trends, reflected in most indicators of real economic activity during the quarter, were not so encouraging. Manufacturing activity showed a progressive decline during the review period, though the services sector held up relatively better than expected. The overall rate of unemployment still remained stubbornly high, forcing the Obama administration to announce a new $440 billion plan to create new jobs by cutting payroll taxes for workers and small businesses, and increasing incentives to employers for new hiring. However, the proposals have not won enough support in Congress and it is now considered unlikely that they will be implemented.
The weaker economic trends and the persistent labor market uncertainties continued to trouble consumer confidence during the quarter. Personal income growth weakened further and, though consumer spending continues to expand, the rate of growth has slowed as consumers are less inclined to increase their borrowing. Stagnant retail sales growth for the month of August further confirmed this trend. Despite record low mortgage rates, most signs from the housing market remained weak, except for housing inventories and the number of homes in foreclosures that have trended lower.
The weaker economic signals forced the Fed to come out with a plan to increase the average maturity of its bond portfolio, by selling short-term issues in favor of long-term bonds. This $400 billion program that will last through June 2012 is intended to keep long-term interest rates low and help the economy recover. Earlier in the quarter, the central bank took the unusual step of assuring the markets that it would retain the current low fed rate at least until mid-2013. These Fed measures, along with the downbeat global economic outlook and the worsening European debt crisis, depressed treasury yields even further during the quarter.
Portfolio Review
After lagging very marginally in July, relative outperformance in August and September helped the Fund outperform the benchmark for the quarter. The Fund’s relative performance during the review period when equity prices steadily weakened highlights our strategy, which seeks down market protection as one of the objectives. Defensive sectors like consumer staples, utilities, value retailers, and property REITS that yield steady cash flows outperformed during the quarter as investors shunned riskier assets. Companies, in industries sensitive to economic cycles such as energy exploration service providers, metal producers, industrial goods manufacturers, and builders were the worst performers during the quarter.
In the Fund’s portfolio, prison and detention center operator Corrections Corporation of America (+4.8%) posted a positive return during the quarter after it received new contracts from the states of Texas and Hawaii and purchased a correctional facility in Ohio. Cigarette manufacturer Reynolds American Inc. (+1.2%) was lifted by investor preference for consumer staples issues as the markets turned more volatile. Electric utility and power producer Edison International (-1.3%) received approval for a new transmission line and reaffirmed its earnings guidance. Discount retailer Ross Stores, Inc. (-1.8%) held up well as consumers continued to downshift amid a slowing economy. Industrial products distributor W.W. Grainger, Inc. (-2.7%) benefited from healthy sales growth and the acquisition of a European distributor. Robust earnings guidance for the current year, as well as an accelerated stock repurchase plan helped business advisory services provider FTI Consulting, Inc. (-3.0%).
Building materials maker Owens Corning (-42.0%) was the worst performer in the portfolio, despite raising its earnings guidance, as the continuing weakness in the domestic housing market and the renewed economic uncertainties have restricted new construction activity. Harsco Corp. (-40.5%), which also provides industrial services to the metal industry, and steel maker Steel Dynamics, Inc. (-39.0%) lost value as demand outlook softened and prices of metals corrected. The correction in oil prices and weaker outlook for energy exploration activity affected the portfolio’s holdings such as explorer and producer Plains Exploration & Production Co. (-40.4%), oil drilling contractor Unit Corp. (-39.4%), and oilfield services provider Oil States International Inc. (-36.3%).
U.S. Domestic Outlook
While there is growing awareness about the long-term fiscal damage caused by uncontrolled government spending and the ever expanding entitlements, there is very little consensus over a comprehensive framework to tackle the problem. On the contrary, the proposals floated so far have shifted the policy preferences of the two political parties farther from the center, making political accommodation more difficult. The upcoming presidential election cycle in 2012 will likely reduce the opportunities and scope of bi-partisan legislation even further. Also, the sustained demand from global investors for U.S. treasuries has prevented the country’s fiscal challenges from being properly reflected in long-term bond yields. Unlike Europe where rising borrowing costs are forcing governments to accept difficult budget choices, very low treasury yields in the U.S. have helped perpetuate the policy inertia.
Though the broader economic trends remain downbeat, recent data suggest that the prospects of select segments of the economy remain relatively healthy. Capital goods orders were higher in August and aggregate industrial activity expanded in September, when automobile sales also gained pace. These data points confirm the still expanding demand for U.S. manufactured goods, especially in emerging economies that are collectively forecasted to grow at 6% this year. Though the recent strength of the dollar would somewhat dull the competitiveness of U.S. exporters, we expect the currency gains to be a short-term trend so long as Europe and the U.S. are able stave off a recession. Corporate earnings, though susceptible to an economic downturn, have so far remained healthy. In any case, as most large U.S. corporations have expanded significantly in overseas markets, they are less dependent on U.S. domestic consumption.
Cash holdings by large corporations are at a record high and several of them, including firms that had never considered such a move until now, are stepping up share buybacks as equity valuations turn lower. Further, if equity prices remain depressed, it is likely that companies with large cash balances and dominant market shares will look at possible strategic acquisitions. We believe these trends will likely support equity prices going forward. Record low bond yields will likely encourage investors to look for income replacements, and dividend paying equities are one way to accomplish this with record amounts of cash available to support future dividends.
We take this opportunity to assure you that our extensive and disciplined investment research process is designed with relative downside protection as a primary objective. Thank you for your continued trust in the Thomas White American Opportunities Fund.
Fund holdings and sector allocations are subject to change at any time and are not recommendations to buy or sell any security. Please click here for fund holdings.
Opinions expressed are subject to change at any time, are not guaranteed and should not be considered investment advice.
Mutual fund investing involves risk. Principal loss is possible. Investing in international markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investments in smaller companies involved additional risks such as limited liquidity and greater volatility.