One of the most famous baseball seasons in history ended in 1951 with a one-game playoff to see which National League team would play in the Major League World Series. The New York Giants (the forefather of my beloved San Francisco Giants) faced their cross-town rival Brooklyn Dodgers at the Polo Grounds for the National League pennant. In the bottom of the ninth inning, Bobby Thomson of the Giants hit a fastball over the fence off pitcher Ralph Branca to win the game. The screaming announcer is ever remembered for repeating, "the Giants win the pennant, the Giants win the pennant."

We think another shot "heard around the world" occurred on August 23rd of 2016, when the U.S. Commerce Department reported that new home sales surged 12.4% to a seasonally adjusted annual rate of 654,000 units in July, the highest level since 2007. This was 74,000 more homes than economists had expected and was stunning in the same way that Bobby Thomson's home run was stunning.

It’s no secret that we’ve argued millennials will drive the economy through home purchases and household formation over the next decade. Even patient value investors like us were starting to wonder when they would show up. It seems that millennials are getting sick of their Mr. Potter-like landlords gouging them with rent increases.

Despite compelling demographics, most investors, stock pickers and members of the media have ignored the explosion of weddings, births and household formation.We believe this causes the public and stock market participants to maintain an extremely negative view of the U.S. economy. The negativity has made our stance lonely. While investors poured dollars into technology companies, consumer staple businesses and telecom/utility stocks, our investment discipline forced us to sit patiently waiting to benefit from the change we see coming from a better economic future. We believe these popular investments are unrelated to the groundswell that a dramatically better level of economic activity could spawn if our largest population group reproduces. Sometimes it feels like we are being given an unfair long-duration advantage over most of our competitors.

Ironically, many years later we learned that the 1951 Giants did cheat the Dodgers by stealing the catcher's pitch signs from a hole in the outfield fence. The catcher put down one or two or three fingers to prompt the next pitch selected. Bobby Thomson knew what pitch Ralph Branca was going to throw. In the major leagues, just because you know what the pitch is going to be doesn't mean you will hit it over the fence, but the Giants entered those dramatic final moments with a huge advantage via their skullduggery.

Therefore, we have two challenges. First, we must look through the news for signs of prosperity coming from a boom in housing the next ten years. It is estimated by astute folks that the U.S. needs housing starts of 1.5 million per year for a decade to meet the future demand from 86 million people currently between 21 and 40 years of age1. We are running 40% below historical norms, but this latest report from the Commerce department should surprise even the most pessimistic observer. Don’t think for one minute that the US Federal Reserve Board missed the latest statistic. Recent demographic studies show that women between 30 and 45 are seeing a huge jump in fertility and we are just getting started2. Our challenge is to be patient and lonely while other areas are making people money in the stock market.

Second, we must scrutinize our portfolio to lean on discounted securities which can be held a long time because of their quality. We must also lean the portfolio toward companies which would benefit from stronger economic activity driven by household formation and in turn home buying. We’ve watched companies which have been in an interest rate nightmare who will gain the benefit of a pickup in activity. They should enjoy an improvement on the spread between what they pay on deposits and what they take in on loans. The following are a few attractive ways which we believe we could make quite a bit of money from these circumstances:

Aflac (AFL)- sells supplemental health insurance which is needed by the parents of newly-minted families. Aflac had Yogi Berra make the case in a commercial by saying “If they get hurt and miss work, they won't be hurt because they missed work.” They also run a huge bond portfolio which would benefit from higher interest rates.

Berkshire Hathaway (BRK.B)-The largest owner of Wells Fargo (WFC), American Express (AXP) and Bank of America (BAC): Berkshire Hathaway has loads of cash on its balance sheet and would like to see capital get more dear for reinvestment purposes. They are the second largest residential real estate agency, own Shaw Carpet, Benjamin Moore Paint, the Burlington Northern Railway(moving timber) and a slew of other housing-related businesses.

Wells Fargo (WFC)-We believe they are the best residential real estate bank and a key mortgage lender. The big banks will get more velocity from stronger GDP and millenial home buyers will demand mortgages and car loans.

All three of these are cheap on an absolute basis, extremely cheap relative to the broad index, and make us feel a little like Bobby Thomson in the batters box knowing what pitch is coming. If we trust the pitch coming and put a good swing on it, home sales in the U.S. may be another “shot heard around the world.”

Warm Regards,
William Smead

The information contained in this missive represents Smead Capital Management's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.

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1 Zelman & Associates

2 U.S. Census Bureau

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