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By Jeffrey Ptak, CFA | 06-25-2015 03:00 PM

Nygren: The Market Is About Where It Belongs

Although not as cheap as it was, the stock market's valuation today isn't much different than long-term historical averages and is more attractive than competing investments like bonds and cash, says Oakmark's Bill Nygren.

Jeff Ptak: Hi, I'm Jeff Ptak, global director of manager research, coming to you from the 27th Annual Morningstar Investment Conference, held here in Chicago. I'm very pleased to welcome a special guest, Bill Nygren, portfolio manager of the Oakmark Fund (OAKMX), Oakmark Select (OAKLX), and Oakmark Global Select (OAKWX) funds.

Bill, welcome. We're very pleased to have you participating in this year's conference.

Bill Nygren: Thanks for having me, Jeff.

Ptak: It's our pleasure. So, Bill, I know that you're a bottom-up stock-picker. You go security by security, but given the perspective that you have on markets, we're always curious to know what you're seeing from your vantage. How target-rich does the equity market look to you right now? Does it appear rich, undervalued, about right? How are things looking?

Nygren: I think when you start thinking about that question, it helps to look backward a little bit. Seven years ago, the market was at a very low P/E on very low earnings. From that level, we tripled. So, if you think about that as a once-in-a-generation opportunity, the market clearly isn't as target-rich as it was then. However, where we're at today is an upper-teens multiple. That's not that different than long-term historical averages. Competing investments like bonds and cash offer de minimis returns.

So, I think the market is about where it belongs, and people have to remember that that doesn't mean it's time to sell the market. If the market is about where it belongs, it ought to return several hundred basis points a year more than the bond market. And if you select securities well, going to some of the out-of-favor areas, I think you should be able to do a little better than that--maybe getting up to upper-single-digit long-term rates of return. That may not sound exciting compared with a triple over six years, but it pretty significantly beats other opportunities today.

Ptak: Jeremy Grantham of GMO was a keynote speaker yesterday. One of the things he noted was the fullness of corporate profit margins--his argument being that they are unsustainably wide. So, to what extent should that color an investor's views about the potential for future stock returns? Should one think that markets can't do quite as well for them in the next seven years as perhaps they have in the past five or six?

Nygren: Well, I clearly don't think the market will do as well as it has in the past five or six years. That would be heroic to think it could triple again. At Oakmark, when we try to estimate what a business is worth, we're always thinking about where earnings will be five to seven years from now--what kind of multiple would be appropriate?

So, we generally include a lot of reversion-to-the-mean thinking in our analysis. But when you look at profit margins and the growing percentage of profits that are coming from outside the United States that are taxed at a fraction of what the United States tax rate is, when you look at how much return we're getting on intellectual property today rather than metal bending, I think there are some pretty strong reasons why today's higher margin levels are sustainable.

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