There are plenty of ways to get ahead. The first is so basic I'm almost embarrassed to say it: spend less than you earn. – Paul Clitheroe
I am drafting this letter from a park in Paris. It is early on a Wednesday afternoon, and the park is full of families. Nearby, men gather to play boule, have a smoke, and enjoy a drink with friends. It is glorious. It's a scene that is repeated throughout France and Western Europe (OK, replace the boules with something else depending on your country). It’s much less common in the United States. It is exceedingly rare in Asia.
According to a Credit Suisse study, in 1980 Europe accounted for as much as 35% of global GDP growth per year. This year it will be 12%. Yes, some of this is due to the advent of economic development in countries like South Korea, Brazil, and China, but the share of world GDP attributable to the U.S. has held much more stable. And keep in mind that at the same time, the debt levels of many European countries have soared, as has unemployment. This debt has purchased lots of things, but it has not been sufficient to keep Europe up to speed with the rest of the world in economic development. And generally speaking, debt must eventually be repaid, a process that removes economic capital from a system. That process is currently underway. In France in 2011, more than 10,000 businesses declared bankruptcy, while fewer than 600 were formed.
All your bras are belong to us
It’s not getting better, either. France has long been associated with sophisticated lingerie, but news that a bra factory in Yssingeaux, a small town in south-central France, will close in favor of outsourcing production to Tunisia has made women’s underwear both a symbol of everything wrong with the French economy and a touch point of the ongoing French election campaign. As one journalist put it bluntly: If France can no longer make bras and lace knickers, what can it make?
None of this is to dismiss the attractiveness of the European way of life. Let's face it -- if living is in itself a pursuit, then the Europeans are better at it than anyone. (Take a deep breath, Californians -- it's not even close.) Their cities are pleasant, their infrastructures mighty, their social structures extremely robust, their vivre full of joie. If I could figure out how to live in Europe but work in America, I'd do it. In a heartbeat.
But traveling back and forth between Europe, Asia, and the U.S. (which I’ve had the pleasure to do, all in the past month), I find the spectrum of the striving nature of Asian commercial activity to the languid attitude Europeans have toward hard work to be nothing short of amazing. Greece offers state employees a thirteenth month of pay. Paid maternity leave in Sweden can be as much as two years. A full work week in France is 36 hours.
Meanwhile in Korea, children attend intense cram schools, both after class and on weekends, preparing to take the standardized tests that determine how prestigious a college they can attend. Chinese workers endure long hours doing, in some cases, backbreaking work. Best of all, in country after country in Asia, systems are being put into place to help bring economic development to a wide portion of the populace. In Europe, they're simply trying to minimize failure. A noble pursuit, indeed, but not particularly effective as a strategy to remain competitive.
The end of the story here is that the rapid growth of Asia and the stagnation of Europe seem to me to be outcomes of broader policy. It is not a sure thing that a society predicated on hard work will outperform one that has perfected the art of leisure, but that's probably the best way to bet.
So where is America in all of this?
Both in Asia and in Europe I heard the same thing (which makes it so strange that I heard the opposite when I was in North Dakota): America is viewed by much of the world as having a nearly absurd amount of creative spirit, something that neither Europe nor Asia have been able to match.
And if you think about this, just focusing on three vectors -- entertainment, technology, and brands -- evidence suggests this is true. America has 5% of the world's population, but an entrepreneurial capacity that is many times higher. In the past I've argued that American schools are much more effective than statistics would suggest, so I won't rehash that here. But suffice it to say that America's educational system does a really good job of educating high achievers. Now no politician could ever say such a thing without being accused of ignoring the needs of all American children. But the world is not looking to South Korea -- the country with the highest average scores in math and science aptitude tests – for the next great creators of economic wealth; it’s looking to America. Ability at the mean to perform well on a standardized test and encouragement of entrepreneurial creativity are two very different educational pursuits. The scoreboard suggests we do the latter very, very well.
Over the past month the market has continued to soar higher as economic growth in the U.S. and a reduction of fears in Europe have convinced many investors that the water is indeed OK for risk assets. Where these people were several months ago when the stock markets were much weaker is beyond me, but there you go. The problem, of course, is that the absence of fear of risk is far different than the absence of risk. European politicians seem to believe that things are improving (and they are), and that they have done all that they can (they have not) to solve the myriad problems Europe faces. In the last week of March, we began to see some of the results of European complacency as the Spanish government's bond auction went absolutely horribly, sending markets back into a tailspin.
Lest you wonder if we've seen this pattern before, rest assured that we have. Politicians have very little capacity to solve problems before they become crises, for the simple fact that they tend to not act with great courage until all other avenues have been exhausted. This isn't a slap at politicians (not a direct one, at least), but a recognition that no politician has ever gotten credit for averting a crisis that is unseen by the general populace, and even then there are entrenched interests in maintaining the status quo as the plane flies into the ground. It's a simple bedrock principle of the "economics of politics." So while Europe remains in a state of relative calm, little will get done.
So why do we have money in Europe?
If we see so little vitality from Europe, why do we invest there? First of all, the fact that Europe has been in crisis is obvious, which means that investors everywhere -- including in Europe -- have been looking for other places to put their money. When this happens, investors tend not to differentiate between the great and the not-great. And second, even if Europe were toast (which it isn't), that doesn't mean that every company in Europe is equally hosed. Many of the world’s great brands are European, and many of them generate much, if not most of their revenues in other markets around the world. I was shocked by the low level of GDP growth that Europe accounts for, because Europe accounts for so much mindshare everywhere in the world.
Last month we met with managers from several Chinese sports apparel companies, and left the meetings thinking, "Adidas is going to crush these guys." (As an aside, meeting with competitors of one of our portfolio companies is often more informative than meeting with the company itself.) European companies have not forgotten how to make money, and European managers have not forgotten how to run these companies well. This is meaningful, and as long as the world's investors view Europe as a basket case, we believe there will be opportunity for those who focus on individual companies rather than on broad-based markets.
Consider, for example, Italian leather goods maker Tod’s SpA, which happens to not only be our largest holding in the Epic Voyage Fund, but also our best-performing holding during the month. Although the Italian market continues to get (rightfully) shellacked, Tod’s continues to outperform sales expectations in emerging markets and throw off cash at a magnitude that should be the envy of most other Italian and/or luxury consumer goods companies.
Monthly Results
It was a good month for domestic stocks and a weak one internationally. Our funds followed those results, with excellent returns domestically (Great America Fund), decent results globally (Independence Fund), and flat results internationally (Epic Voyage Fund). All three funds outperformed their benchmarks by varying degrees, reversing results from February when all three underperformed.
For the month, the Independence Fund gained 1.38% vs. 1.34% for the benchmark MSCI World. Little changed in the portfolio, and some of the usual suspects in our Top 11 holdings were among the biggest contributors to a good month, such as Yum! Brands (on general enthusiasm for the consumer sector) and a big comeback from WellPoint on speculation that the Supreme Court would overturn the Patient Protection and Affordable Care Act. Recent addition Crucialtec joined Posco in having a poor month, largely on the back of weakness in the Korean market. As we’ve noted in the past, South Korea is the largest component of the MSCI Emerging Market Index. As such, when thematic investors “reduce exposure” to emerging markets, companies in the Korean market tend to be hit disproportionately hard. Add in the prospect of a North Korean missile test, and you have the makings of a tough market environment.
The Great America Fund increased in value by 2.44% vs. a 2.24% performance for its benchmark. Little changed in the portfolio. We liked what we owned, though by the end of the month, given the increase in prices across the market, it was becoming harder to find things we were especially interested in adding.
Despite turbulence in international markets, it was a fairly quiet month for the Epic Voyage Fund, which was a dead flat 0.00% in March versus a 1.36% decline for its benchmark, the Russell Global ex-US. Our only transaction of note was to sell our shares of Canadian yoga apparel maker Lululemon. You may remember that when we talked about Lululemon during our January shareholder conference call (and compared it to craft beer), it was already quite an expensive stock. And while we endeavor to be long-term owners of great businesses, it’s also true that our stocks are on sale every day -- and we believe we received a price that more than compensated us for the value of Lululemon’s brand and growing store franchise. We would love to own this company again at the right price, but we think that the shares are currently valued for absolutely extraordinary future results.
As always, the entire portfolio team joins me in thanking you for entrusting your money with us.
Foolish best,
Bill Mann
