Letter to Shareholders
June 29, 2010
One Financial Place
440 South LaSalle Street, Suite 3900
Chicago, Illinois 60605-1028
Dear Shareholders and Friends,
We are delighted to welcome our many new shareholders. You join a growing number of individuals who have entrusted us to manage a portion of their savings. Our response to your confidence has been to expand the number of our research analysts. These professionals assist us in better understanding the economies of various countries across the globe, and who help us discover the investment opportunities that drive our performance. We are equally committed to continually improving our level of service and communications to you and your advisor.
Knowing Your Advisor
Every organization has a unique character. Perhaps what differentiates us is the genuine enthusiasm of our research professionals. They view themselves as being at the epicenter of a powerful and exciting period of transition and growth worldwide. They see a growing global convergence of business and capital markets and increased cooperation among nations to solve problems and avoid the conflicts that gripped the 20th century. They feel that ongoing globalization, despite the many bumps in the road that will occur over the coming decades, will lead to sharp improvements in the standard of living for all of humanity.
Our collective goal is to capture the associated investment benefits of globalization for our shareholders. We recognize that to accomplish this it is important that our clients stay well informed on the progress of globalization as it transforms the 45 countries covered by our analysts. The Thomas White-Global Investing website, www.thomaswhite.com, now draws throngs of visitors from around the world, demonstrating to us the rapidly growing appetite for global investing.
The World Economy
We continue to expect that the world economy will grow over 4% in 2010, a sharp improvement compared to the 0.6% contraction in 2009. The emerging market economies, and particularly those in Asia, continue to be the engines that are driving global growth.
In the developed markets, our analysts see slower growth in Europe, North America and Japan. We feel that these recoveries, most of which began during last year’s second quarter, will continue in the second half of 2010 and later in 2011, but at a low single digit paces. We also believe that the U.S. economy will outperform Europe and Japan, but not by much.
Many emerging market economies are experiencing accelerated high single digit growth. China has again expanded in double digits, but has moderated loan growth to reduce housing speculation. India’s policies are being adjusted in an attempt to temper food inflation. Many countries have strong capital inflows but recognize this infusion of capital is not a dependable way to finance growth.
Emerging Market Countries
Why we have started an Emerging Markets Fund
We have long believed that if an investor understands as we do that globalization is a positive force that encourages moderation and provides many new opportunities for growth, then they will also see the advantages of adding international equities to their portfolios. Multinational corporations have been using this global strategy for years; why shouldn’t investors do the same? Since our founding in 1992, emerging market countries have grown from a mere 3% of the MSCI All Country World Index to approximately 21% today. But, given they have just started to develop their equity markets, we believe that this weight is deceptively low. In fact, 2010 IMF data confirms emerging market countries represent 47.1% of the total world economy, and the IMF projects this will grow to 51.9% by 2015.
What Caused Emerging Markets to Catch Up with Developed Markets So Quickly?
Perhaps the better question is what held back the emerging markets, representing 87.9% of world’s population, from progressing at the same rate as the others? Russia, China and India all had sophisticated cultures and global competitive societies in the past, but development had been delayed by politically-driven, failed economic models. When they ushered in market-driven economies in the 1990s, growth began to accelerate immediately. Add global CNN news via satellite and later the Internet and voila! - the world was competing on a more equal footing.
Companies quickly became multinational, selling worldwide and moving their manufacturing operations to countries where labor was cheapest, most often in emerging economies. At first, this was a positive for the consumer in developed markets, as products became progressively cheaper. Eventually job losses rose in developed countries, but their governments came to the rescue by extending unemployment payments and promoting domestic growth by subsidizing low cost home mortgages …all done with borrowed money from the emerging market countries where workers had the discipline to save large portions of their salaries.
Please excuse this simplification of the story, but the message should be clear. By 2008, the emerging markets’ “export and lend model” and the developed markets’ “consume and borrow model” had gone from benefiting participants to damaging them. The emerging market countries are now concentrating on expanding domestic consumption to replace lost export revenues. In this area, China, India, Indonesia, Brazil and other countries with huge populations have clear advantages.
Developed Countries
AAA Financial Behavior is the Only Thing Trusted in Today’s World
Financial managers in what the IMF labels advanced economies are no longer extolling the advantages of financial leverage. Today, being successful as a financial manager requires a much different approach. Before 2008, many companies and governments naively believed they could generate sustainable growth by increasing their level of debt. Those same entities are now in trouble. They had been lured into a trap, baited by their zeal to succeed, and unwilling to recognize the history of such behavior. Actions were often taken by political and corporate executives whose terms would be over before the “piper had to be paid.”
Today investors recognize that many government and business leaders that had been viewed as successfully climbing mountains were in fact digging deeper and deeper holes. The leader now most admired is cut from a different cloth. He or she is also an expert at climbing, but this time the challenge is to climb out of the hole their predecessor left behind. While both leaders of yesterday and today had to build supportive constituencies, the former had a far easier sell. They sold having a party, while their successor now has to sell the virtue of facing reality and the sacrifice necessary to right the financial ship.
Today’s “born again” lenders and investors like us demand that chief financial officers commit themselves to spending within their means. Perhaps even more important, they must have the backing of their constituents, be they electorate, stakeholders or shareholders. Why? They need the authority to make painful spending cuts when necessary. If done early, adjustments are seen as discipline.
At this stage in the recovery, the next group of financial leaders who are going to be forced (by bond investors) to face financial reality are the elected officials of those government entities, like California and Illinois, that cannot issue their own currency. Cynics would suggest they are resisting because they face losing their coming elections. But then again, who among us has the courage to cut the support of homeless children or to lay off 20% of a school system’s teachers when they already have 35 students per class? It is understandable that these leaders will wait until they are forced to act. As Greece is learning, just like death and taxes, the market makes the rules. Facing reality will slow both local and global growth and raise unemployment, but delaying the inevitable only lengthens the recovery period.
What about the government entities that can print their own money? Here fiscal austerity means slower growth and higher unemployment, while printing money eventually brings high inflation. But what investor would buy a country’s sovereign debt with a future threat of high inflation? Transparent AAA financial behavior is the only thing trusted in today’s world; without clear fiscal discipline investors are even becoming skeptical of America’s AAA credit rating.
The Good News
The good news is that equity investors are forward-looking. Using history as a guide, markets bottom during a crisis and recover afterwards. The market recovery since the financial crisis of 2008 is typical of the past. The tide went out in 2008, and the market was shocked to find that so many past heroes were naked. We have been in the repair phase ever since - first the banks and the debt laden home owners, then non-financial businesses like GM , now the small countries, and next the states and municipalities. Investors have typically recognized that this therapeutic stage is the necessary precursor to a healthy sustainable recovery.
Given the extremes that were reached in the past era of undisciplined lending, it is prudent to expect additional “after shocks” similar to the recent Greek sovereign debt crisis in Europe. We expect coming credit scares will involve the excessive debt and deep fiscal deficits in California, Illinois, New York, New Jersey, Arizona and many others states. These credit-related speed bumps will no doubt upset the market, but we feel this will be temporary, as tough decisions are inevitable and putting them behind us is a necessary step toward building a sustainable economic recovery. We understand that the act of deleveraging after periods of widespread consumer, business and government excesses will slow growth. Nevertheless, our professionals are far more comfortable when problems are widely recognized and “Mr. Market” forces even the most intransigent to set their financial houses in order.
The Dollar has been Strong
Last December, we suggested the dollar may outperform the Euro, Sterling and Yen due the relatively stronger recovery we felt America would enjoy. While longer term, we feel the dollar is vulnerable due to its poor financial discipline, temporary conditions suggest its continued mild outperformance against developed market countries. America’s current account improvements were helped by falling commodity prices and interest rates, but these conditions seem to have ended.
Our Portfolio Strategy
We strongly believe investors will be well served owning equity portfolios of sound companies that are broadly diversified across the world’s regions and industries. While equities are the most volatile asset class, history shows they have produced superior, inflation-adjusted returns over the long term. Well-run companies with prudent balance sheets have demonstrated the ability to survive a wide range of economic and business storms and come back more valuable than before. By being able to handling these challenging times better than their weaker competitors, these companies should be able to use their advantages in scale, lower costs and greater access to capital to increase market share in their industries and acquire valuable companies or divisions at fire sale prices. Like us, company managers with long-term horizons recognize that difficult environments can offer exceptional buying opportunities.
Your Portfolio Manager, and Many Members of Our Research Team, Are Fellow Fund Shareholders.
As do many in our firm, I have 100% of my stock market exposure in the Thomas White Funds, including the newly launched Thomas White Emerging Markets Fund. During this period of rapid change in the world’s markets, I urge you stay abreast of the important events occurring in the forty-five countries covered by our analysts. Their observations are available at www.thomaswhite.com. You may subscribe on the site to get this content sent to you by email.
Sincerely yours,
Thomas S. White, Jr.
President
FORWARD LOOKING STATEMENTS
Certain statements made above may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. and the Thomas White Funds undertake no responsibility to update publicly or revise any forward looking statements.
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