3Q17 Letter to Shareholders: The Calm Amidst the Storms



Hurricane Harvey came first, pummeling Texas on August 25th. Less than two weeks later, Irma battered the Caribbean and Florida. Jose and Maria soon followed, again striking the Caribbean and disabling much of Puerto Rico’s infrastructure. In less than a month, four storms (two rated Category 4 and two Category 5) left a trail of destruction—estimated in the hundreds of billions of dollars—that will take months, if not years, to repair. Yet the financial markets hardly blinked.

Hurricanes weren’t the only storms that afflicted the third quarter. There were the political storms over health care, the debt ceiling, the National Football League and the Russia investigation. The storm of words between North Korea’s supreme leader Kim Jong Un and President Donald Trump raged. The belated announcement of a data breach at Equifax, potentially affecting nearly one of every two Americans, unleashed a storm of concern about cybersecurity. The Trump Twitter storm was unrelenting. And yet the markets hardly blinked.

So far at least, regardless of the perils that have dominated the news day after day, the economy and markets have continued to advance. Truly, it’s been the calm amidst the storms. Which, of course, begs the question: Can it last? Or, from an investor’s point of view, might this be the calm before the storm in the financial markets?

As you know from my prior messages, I’ve been cautiously optimistic regarding the market. However, I’ve also mentioned my concerns that some type of geopolitical event like those mentioned above will ultimately bring the market down. The fact this hasn’t happened is puzzling to me. That the combination of events, the bull market’s long duration, and the high valuations of stocks and bonds hasn’t led to a decline is a testament to the strength of the market.

Is this just due to complacency in the face of a bull market that’s clearly long in the tooth? First a little bit of my personal history, and then my best argument for the bull market continuing a while longer. My Dad became a stockbroker for Merrill Lynch when the firm opened its Salt Lake City office in the 1950s, the first Merrill office between Denver and San Francisco. I was a curious kid and read everything about the markets my Dad would pass along to me. Back then, there was a basic trading rule the bears today are ignoring: “Don’t fight the tape.” And while ticker tapes are no longer used to track stock prices, it’s still true that market trends aren’t easily reversed.

Generally speaking, financial markets take their cues from the economy. In my message last quarter, I pointed out that the economy has for some time been in a “Goldilocks” state—neither too hot nor too cold—sustaining low inflation and rising asset prices. While investors have been quick to complain about the economy’s slow growth rate, it’s that very same measured pace that so far has prevented the economy from developing the excesses that typically lead to recessions and market declines.

With the current economic expansion now in its 100th month, the third-longest run since 1854, it’s important to note that recessions don’t occur in response to a timetable. Rather, they result from problems in the economy, of which there appear to be few. Accordingly, some analysts believe there’s a good chance the current economic expansion will become the longest on record, surpassing the 10-year run from March 1991 to March 2001.

I’m reluctant to go on record with a message supporting the continuation of a bull market without also making an argument for the onset of a bear market. My bear-market argument depends on an unexpected event/catalyst, possibly geopolitical in nature. I’m not predicting such an event, and I’m surprised that one of the events cited above didn’t lead to a market correction. Even so, I still regard an event as the likely cause of the next bear market. Recently, Robert Shiller noted that valuations are stretched and it’s concerning that the current market seems to ignore completely the possibility of some bear-inducing catalyst.

I’m forced to conclude that the continuation of the bull market relies on the financial equivalent of Newton’s law: an object in motion tends to remain in motion.


During the third quarter, global markets exceeded the stellar performance of the previous period. Among the 145 stock, bond, municipal, U.S., foreign, target and commodity indexes found on, all but four were positive for the quarter. In the U.S., the large-cap S&P 500® Index rose 4.48%, the Russell 2000® Index of small caps moved up 5.67% and the technology-heavy Nasdaq Composite Index advanced 6.06%. Bond markets also gained, as the intermediate-term Bloomberg Barclays US Aggregate Bond Index returned 0.85% and the long-term Bloomberg Barclays US 20+ Year Treasury Bond Index inched up 0.58%. International stock markets were quite strong too. The MSCI World ex USA Index rose 5.62% and the MSCI Emerging Markets Index advanced 7.89%.

Many of my recent messages, including this one, have commented that stocks—particularly in the U.S.—are expensive. However, I must admit that stocks aren’t as expensive if we consider the level of interest rates. After all, the inverse of the price/earnings (P/E) ratio (the price paid for $1 of earnings) is termed the earnings yield or the return in earnings for $1 of investment in a stock. The interest rate on a bond is the return in cash for $1 invested in the bond. While I won’t argue that the earnings yield on a stock and the interest rate on a bond are equivalent, they are related.

Going back 35 years when interest rates were in double-digit territory, P/E ratios for stocks were in single digits, with the result that the earnings yield on stocks was in double digits. In comparison, stocks today look quite expensive, with multiples close to three times what they were back then. However, that comparison overlooks the fact that bond rates are now only about one-fifth of what they were then, making bonds five times more expensive today than they were 35 years ago.

Avoiding much of the detail about what makes our economy today different from that of 35 years ago (and ignoring the risk premium stocks must offer for providing investors with earnings instead of cash), I could argue that stocks today are inexpensive relative to bonds. So if bonds aren’t overly expensive, then neither are stocks.

This might lead one to ask: Are bonds expensive? Relative to recent history, bonds in the U.S. seem expensive. Bond yields have generally fallen from double-digit territory into low single-digit territory. Ten-year U.S. Treasury bonds currently yield about 2.3%. However, German and Japanese government bonds of the same maturity yield less than 0.5%. Moreover, five-year government bonds in Germany and Japan have negative yields. So U.S. government bonds certainly aren’t expensive on a relative basis.

In a sign that interest rates overseas may remain low, some countries have been issuing 100-year bonds. Austria, for example, recently issued bonds that won’t mature until 2117 and that yield just 2.1%. Other recent issuers of 100-year bonds include Argentina, Ireland and Mexico. Purchased mainly by institutional investors to meet long-term pension and insurance obligations, these bonds indicate that slow economic growth around the world may constrain future investment returns. Why else would an institutional investor tie up money for so long? As for interest rates in the U.S., I have to wonder how much they can rise when rates are so low overseas.

Why are interest rates so low? At the heart of this question are cyclical vs. secular forces. If rates are low because the economy is weak, then the cyclical forces of our strengthening economy should drive rates higher. The fact that this has failed to happen suggests secular forces may be at play. For example, changing demographics may be weighing on interest rates. As people get older, they’re less likely to build new homes. Instead, they’re more likely to be downsizing. The primary concern of most older people is having adequate savings to support themselves in retirement. This global flood of savings is likely playing a major role in keeping interest rates low.

If in fact secular forces are keeping interest rates low, these forces may also be keeping stock prices high. So while valuations are stretched relative to earnings, they may not be as stretched relative to interest rates. For this reason and for the reasons discussed above, I remain cautiously optimistic that the economy and markets, both in the U.S. and abroad, will continue to advance at a slow pace overall.


While U.S. equities are generally more expensive, we’re often finding better valuations and/or greater headroom for growth overseas—both in developed markets and in emerging markets. On our website, we recently posted two white papers, a new one on Japan and a recently updated one on India. These white papers detail the political and economic factors that make each of these countries attractive to us as investors. Indeed, Japan is one of our largest investment allocations to an international developed market and India is one of our largest allocations to an emerging market.

In our Japan paper, we readily acknowledge that for many years—particularly in the 1990s and 2000s—Japan’s economy was mired in deflation, creating a difficult investment environment. For many investors, the perception remains that it’s tough to make money in Japan. Moreover, it’s true that the Japanese population is shrinking, the country’s overall economic growth is slow, and there’s not much inflation on the horizon. Nonetheless, we think that investors who look no further than these issues are missing out on significant opportunities.

Known as Abenomics, the economic policies introduced by Prime Minister Shinzo Abe in 2012 appear to be taking hold. Over the past few years, based on our investment team’s frequent visits to Japan, we’ve seen the results of these policies—from improvements in corporate governance to efforts addressing the country’s labor shortage. Such efforts include extending the retirement age, encouraging women to enter the labor force, supporting the hiring of new workers right out of school, and promoting the use of outsourcing and part-time workers.

Because Japan is a global leader in innovation, it’s no surprise the country has an extremely vibrant market for small-cap stocks. This indicates Japan has created an entrepreneurial environment that favors investment. We’ve also found opportunities in Japan’s fragmented industries. Unlike in much of the developed world, there are fewer dominant industry players in Japan. That’s beginning to change, however, and we’re investing in companies that we believe can consolidate their industries and gain market share from competitors.

As mentioned, India is the focus of another white paper I encourage you to read. After investing in the country for over a decade, the members of our investment team are more excited than ever about the investment opportunities they’re finding in India.

With its democratic government and strong institutions, India has avoided much of the political turmoil, massive borrowing, debt defaults and runaway inflation that have plagued other emerging-market countries over the past 30 years. India’s population of greater than 1.3 billion is among the youngest in the world. In addition, the country’s growing middle class, increasing urbanization and rapid household formation are driving domestic consumer demand. Moreover, new initiatives, bureaucratic reforms, tax simplifications, improved labor laws and streamlined bankruptcy procedures introduced by Prime Minister Narendra Modi are designed to further the country’s growth and development.

Beyond the wealth of information on the economic, political and demographic forces that are creating favorable opportunities in Japan and India, both white papers provide case histories on specific investments Wasatch has made. I think you’ll find these papers to be well-researched explanations of why we’re particularly optimistic regarding our holdings in Japan and India.

With sincere thanks for your continued investment and for your trust,


Sam Stewart




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Abenomics refers to the economic policies advocated by Japanese Prime Minister Shinzo Abe after his December 2012 re-election to the post he last held in 2007. His aim was to revive the sluggish economy with “three arrows”—a massive fiscal stimulus, more aggressive monetary easing from the Bank of Japan, and structural reforms to boost Japan’s competitiveness.

A bull market is defined as a prolonged period in which investment prices rise faster than their historical average. Bull markets can happen as the result of an economic recovery, an economic boom, or investor psychology.

A bear market is generally defined as a drop of 20% or more in stock prices over at least a two-month period. Bears are investors who are pessimistic with regard to the stock market’s prospects.

The price/earnings (P/E) ratio, also known as the P/E multiple, is the price of a stock divided by its earnings per share.

Valuation is the process of determining the current worth of an asset or company.

The Russell 2000 Index is an unmanaged total-return index of the smallest 2,000 companies in the Russell 3000 Index, as ranked by total market capitalization. The Russell 2000 is widely used in the industry to measure the performance of small-company stocks.

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The NASDAQ Composite Index is a market-capitalization weighted index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks. The NASDAQ was created by the National Association of Securities Dealers (NASD) to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971.

The S&P 500 Index includes 500 of the United States’ largest stocks from a broad variety of industries. The Index is unmanaged and is a commonly used measure of common stock total return performance.

The MSCI Emerging Markets Index captures large and mid cap representation across 24 emerging market countries. With 839 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 developed market countries—excluding the United States. With 1,020 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

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The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, mortgage-backed securities (MBS) (agency fixed-rate and hybrid adjustable-rate mortgage [ARM] pass-throughs), asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS) (agency and non-agency).

The Bloomberg Barclays US 20+ Year Treasury Bond Index measures the performance of U.S. Treasury securities that have remaining maturities of 20 or more years.

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