17 Jul 2012 Heartland Funds - Q2 2012 Commentary ( Portfolio )
“I think gas is probably the most disruptive technology that we have in the American economy today... gas today trades $2.40 an Mcf, that’s the equivalent of less than $15 a barrel of oil; it’s BTUs on the cheap”
– James S. Tisch, President, CEO & Director of Loews Corporation, May 30, 20121

European equity markets have felt the claws of the bear as they suffer their third year of crisis. Global equity markets have heard its growl too, including the U.S. The S&P 500 rallied sharply in the first quarter, but reversed much of those gains in the second, repeating some of the behaviors it exhibited in the spring of 2010 and 2011. Does three times make a sustained bear market in U.S. equities? We don’t think so, though we do recognize that certain structural problems persist.

• The solvency of peripheral European countries is in question, evidenced by sovereign debt yields that are near their highest levels since the establishment of the Euro. With Greece’s recent vote, cast as a bid to stay in the currency bloc, markets appear to be preparing for a recession in Europe.

• Further afield, China’s export markets are weaker, slowing the break-neck growth China has exhibited in years past.

• The U.S. economy is weighed-down by sub 2% GDP growth. The Federal Reserve has recently recommitted to a low interest rate policy, but Bernanke and his gang remain under pressure. Tax hikes, set to take hold in 2013, and lack of serious discussion regarding entitlement reform, collude to paint a cloudy economic picture, leaving most investors with little appetite for risk.

What a list of negatives!
However, there are positive developments taking root in the U.S. economy that bears can ignore at their peril. To wit:

• The market is a discounting mechanism, which generally incorporates bad expectations in the present-day valuations of securities. The S&P 500 trades at only 13.5 times 2012 forward earnings estimates, implying a very compelling 7.4% earnings yield. We challenge investors to find such yields at acceptable risks in today’s stretched bond markets. Furthermore, many corporations are increasing dividend payouts or are initiating them for the first time.

• Subdued global energy demand can create a benefit for consumers. U.S. industry is a principal beneficiary of cheap and abundant energy. In fact, the U.S. supply of natural gas is considered so large that some have called America the “Saudi Arabia of natural gas.”

• U.S. corporations are loaded with well over $2 trillion of cash! Investors can think of it as a wave of potential investment that is being held back by a near-term levee of concerns and lack of visibility. When unleashed, it should be a positive boost for capital investment.

A bottom may be forming in housing. The
chart illustrates that affordability is far above its 25 year average, based on lower home prices and interest rates, and on levels of median household income.

We believe the fear evident in capital markets today presents a real opportunity to find stocks that are cheaply priced and have ample potential to appreciate. Throughout market history, it is those investors who have had the tenacity and patience to pick up the pieces and own what others will not that have ultimately been rewarded.