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2016: The Year of the Foolish Critic
An effective strategy for judging stock market psychology comes from looking to see which outstanding stock pickers are being singled out for criticism. This happens when they underperform the S&P 500 Index and are invested in out-of-favor parts of the stock market. This also happens when the stock market is limiting its favor to a narrow group of futuristic companies and the historically smart stock picker is not willing to bend their will to the current trend.
Breaking Up Is Hard To Do
At Smead Capital Management we are in the business of attempting to gain a clear understanding of what we refer to as a “Well Known Fact.” A Well Known Fact is a body of economic information which is known to all market participants and has been acted on by nearly anyone with access to capital.
Stock Market Control
We saw the chart below in a recent Marketwatch.com column from Mark Hulbert. It shows the likelihood of the stock market going up or down in the next year, based on how it did the prior year. This got us thinking about what you can and can't control in the U.S. stock market. After all, the reason that stocks outperform other liquid asset classes over long stretches of time is the uncertainty and variability of returns. Here is a short list of things which can't be controlled in the U.S. stock market.
Historical Rates Impact Common Stocks
Time and coincidence often cloud our own perception. Consider interest rates. Baby Boomers and Generation Xers became adults (25 or older) between 1965 and 2005. During that period, these adults witnessed an aberration in the history of interest rates. They saw moments of monumental highs (20%) and levels consistently above historical norms. The chart below shows that long and short-term Interest rates in the United States have spent most of the last 400 years in a range between 3% and 6%.
Innovation and Scotch Tape
In business and economics, a “first-mover advantage” is defined as the benefit accrued to a company whose product is the first to enter a market. These products often create or define an entirely new market opportunity that the world hadn’t known before. Some “first-mover” examples have created very attractive long-duration opportunities. EBAY (EBAY), a company we own in our portfolios, was the first online auction service. It has maintained leadership in that area for the last two decades.
Drilling for Oil on Wall Street
As long-duration common stock owners and investors, we focus on our bottoms-up stock picking and seek to analyze the micro-economics of each industry involved. However, the importance of oil prices to the economy of the U.S. and its effect on inflation helps determine the intrinsic value of our companies. While we currently own no energy companies in our portfolio, we would like to pause and see what the rhymes of history can tell us about the circumstances of today.
We’ve Only Just Begun
Common stock investors are looking at an economic recovery in the U.S., which has not been interrupted by recession since 2009, and a stock market advance with temporary declines only in 2010, 2011 and in the summer this year. Since the declines in price have been something less than 20%, market participants assume that both the economic expansion and the bull market in U.S. stocks are “long in the tooth.”
Contentiousness Du Jour
John Templeton started his investment career in 1939 by buying every stock on the New York Stock Exchange trading under a dollar. He argued that you wanted to buy securities at what he called, “the point of maximum pessimism.” Still reeling from the depression and with war looming in Europe, he certainly found a point of pessimism. Additionally, he noted that “If you can see the light at the end of the tunnel, it is probably too late.”
3Q 2015 Smead Capital Management Quarterly Newsletter: The Red, Green, and Beige Room
One of the great investing books of the last 40 years was David Dreman’s, Contrarian Investment Strategy. He started it by telling of a hypothetical gaming casino with two separate, but adjoining, rooms: the red room and the green room. The red room was packed with people and excitement and almost every day someone hit a huge jackpot setting the building on fire with electricity. Every seat was packed, others waited their turn to play and the anticipation was palpable.
What’s the Market's Biggest Risk?
When meeting with clients throughout the country, investors ask if we are worried about various well-vetted and well-known negatives. The list includes what the Federal Reserve Board might or might not do, China's slowdown, emerging market struggles, plummeting commodities, dollar strength and the uncertainty over who will become President of the U.S. in 2017. We think investors are really asking us, “what’s the market’s biggest risk?”
Stuck in the Middle with You
Unless you have been asleep on the floor for the last six weeks, you’ve noticed that the U.S. stock market has gone down. Even before stocks sold off in August, the average common stock had been performing poorly relative to the S&P 500 Index. In August, the market officially declined more than 10% from peak to trough. An anthem for situations like this comes from the one-hit wonder, Stealers Wheel, who penned the song “Stuck in the Middle with You.”
Competing with the Alpha and the Omega
In the Bible, Jesus said, “I am the Alpha and the Omega, the first and the last, the beginning and the end.” While Jesus infers that he is at both the beginning and the end of time, we as investors can only operate in the present with a knowledge of what has come before. To better understand today's commodity market circumstances, we believe investors should examine the herd mentality and the psychological backing that may lead to contrarian investment opportunities.
The Earbud Stock Market
The earbud is nothing new, but it seems to be everywhere. The first implication of wearing earbuds is the solitary nature it creates. People signal through earbuds that they want to be left alone. Second, earbuds represent a willingness to disengage from the moment—a willful non-participation in society. This seems true in a world that is tied at the hip to technology and dominated by the largest population group between 20 and 36 years of age. This seems even truer for the markets, which greatly matters to long-duration stock owners like us.
Security Valuation: What Can Microsoft and Walmart Teach Us about Amazon?
While most investors and the media consider the merits of Amazon’s workplace environment, we at Smead Capital Management would like to think about the purpose of owning a business and how today’s stock market chooses to price securities. In our case, we choose to analyze companies as if we were buying the whole business at current quotes, not just a small part. We think about Amazon the way we think about all companies—being the receiver of the future profits and free-cash flows.
Video Didn’t Kill the Radio Star
The longer we are in the investment business, the more skeptical we become about the investment crowd’s ability to identify which innovative companies are truly disrupting competing companies. Last week (August 7th of 2015) a sharp correction occurred in the prices of television and other media stocks, seemingly based on concerns that Netflix and other internet-based streaming services would “kill” the TV business. As long-duration common stock pickers who hold media securities, we got to thinking about long-term changes in media.
China’s Command Economy: The Gift That Keeps on Giving
With Beijing being selected to host the 2022 Winter Olympics, we at Smead Capital took a moment to reflect on China. We concluded that posturing against China’s attempt to defy business cycles could be one of the best decisions we have made and could be the gift that keeps on giving. Warren Buffett once observed that you get to make approximately 20 major business decisions in your life. As long-duration common stock pickers, we think what you avoid can be just as important as what you select.
Solomon's Long Duration Investment Wisdom
Storm clouds seem to build by the day. Many investors have an ongoing love affair with a few large-cap and more futuristic companies, yet they have corrected the prices of any stock with disappointing earnings or an attachment to the production of commodities.
Millennial Prosperity
Many media organizations and smart money managers are postulating that today’s 22-35 year old age group (millennials) might be the first generation since World War II to not marry, have children, buy cars and buy houses at high enough percentages to help us fully recover from the financial meltdown of 2007-09.
Where’s Warren?
The conspicuously dressed children’s book character, Waldo, who dons a striped shirt and hat, is hard to miss, unless he’s in strange places or bizarre geographic settings. Similarly, Warren Buffett is often hard to miss. Yet every now and then, some bizarre market event happens, and we must ask, where’s Warren?
The 1982 Playbook
When the stock market exploded to the upside after March 10th of 2009, I turned to my colleagues and said, "It's time to get out the 1982 playbook." The last deep recession with well-above 10% unemployment was in 1982 and stocks had suffered from numerous bear markets. Stocks took off in anticipation of an enduring economic recovery and it paid to believe in its longevity and the positive long-duration effect it would have on stock prices.
Peter Lynch on Today
Peter Lynch was one of the most successful stock pickers of all time. From 1977-1990, he managed the Fidelity Magellan fund and produced returns of 29.2% per year, besting the S&P 500 Index returns of 15.8%. The Magellan fund grew from $18 million to $19 billion in assets during that time period. What Lynch said about market timing and investor sentiment appears very useful to long-duration common stock owners like us.
Frank Sinatra on the Reinvestment of Unrealized Gains
In the song, “That’s Life,” Frank Sinatra tells us everything we need to know about the process of creating wealth in the stock market. We believe a little known component of creating that wealth lies in the reinvestment of unrealized gains in long duration common stock ownership.
Interest Rates Affect on Intrinsic Value
We at Smead Capital Management believe in the value of compounded returns. They are the friend of the long-duration common stock investor, especially when considering the intrinsic value of a company. With so much chatter among investors, the media and analysts over when the Federal Reserve will increase interest rates, we would like to share with you how we think about and use prevailing interest rates in security analysis. Together with earnings growth estimates and longevity, the discount interest rate is a cornerstone of calculating the intrinsic value of a company.
No Looking Back in Stock-Picking
Wayne Gretzky is considered the greatest hockey player of all time. When asked why he was such a great player, he replied, “I skate to where the puck is going to be.” We at Smead Capital believe that investors are stuck where the puck is now. In fact, we theorize that most investors get stuck where the puck was before the last line change. We call this “rear-view mirror” investing. It is our opinion that understanding where we’ve been, where we are now and where we are going is important in common stock selection in 2015.
Sugar and Spice and Everything Nice: Buffett’s 50th Shareholder Meeting
The 50th annual meeting of Berkshire Hathaway with Warren Buffett as Chairman was filled with sugar and spice and everything nice. We at Smead Capital Management always look for three key takeaways from the annual meeting of Berkshire Hathaway. This year we think we can sum it up by using the 19th Century nursery rhyme.
Could Aflac’s Contentiousness Spell Wealth Creation?
At Smead Capital Management, we like to combine the qualitative aspects of a meritorious company with the temporary contentiousness of deeply out-of-favor psychology. We have found in our research that using qualitative attributes alone can be very expensive. Additionally, we feel that just buying stocks off of the out-of-favor junk pile can lead you to bankruptcy court if the companies fail to turnaround.
1Q 2015 Newsletter: Eliminating the Confusion about Active Equity Management
There are a great number of bright mathematicians out there who can explain almost everything in common stock selection and portfolio management. One well-known student of the arena is Michael Mauboussin, a Managing Director at Credit Suisse, who recently published a challenging piece of research seeking to explain how difficult it was last year (2014) for mutual funds to beat the S&P 500 Index. In reviewing his analysis, we are reminded that calling stock picking and portfolio management “active management” has done the investment marketplace a huge disservice.
Common Stocks: A Garden of Wealth Creation
We think the reason most investors do not gain the benefit of common stock ownership stems from the blight which comes along about once every five years on average in the stock market. We call this blight a bear market and it usually consists of a decline of greater than 20% in price from the prior stock market peak. There have been nine declines of that magnitude since 1950 in the S&P 500 Index. Three of those declines exceeded 40% and two of them were in the last 15 years.
Should You Buy in to Oil’s Secular Bear Market?
March 10th is one of my favorite days of the year. The tech bubble of the late 1990's burst on March 10th of 2000 and the biggest bear market of my career (2007 peak to 2009 low) bottomed on March 10th of 2009. There is a great deal to learn from those two dates in history as it pertains to the way secular bear markets work and how long it takes to move from the most popular investment in the world to being completely out of favor.
Find Hated, You May Find Wealth
As we overhear the chatter of major stock market media outlets and read the best writing on publicly-traded companies, we realize how incredibly popular and exciting most of the companies are which dominate investment news. We like to think of it as a love affair between investors and certain “popular” companies. There are numerous contrarians floating around in the media world as well and they caught our attention recently.
Keynesian Contrarianism: Where is the Minority Today?
To get a good feel for where the largest pools of money are invested around the world and to identify the minority, we draw from the NACUBO-Commonfund Study of Endowments in North America. This year’s survey included $516 billion in investable assets. The results for the fiscal year ended June 30th of 2014 are listed below. Pay particular attention to the largest endowments, because we believe they represent the asset allocation of the largest worldwide institutions.
Woody Hayes on Portfolio Management
“There are three things that can happen when you pass the football and two of them are bad,” observed The Ohio State University’s legendary coach Woody Hayes. All the Seahawk fans, myself included, know exactly what he is talking about since the Seahawks chose to pass the ball at the one-yard line. You can complete a pass, you can throw it for an incompletion, or you can throw it to the other team (an interception). The same thing can be said for existing common stocks in your equity portfolio.
The Cacophony of Earnings Announcements
As long-duration common stock owners, we are always interested and entertained when the media covers company earnings. To understand why, we think you need to know the facts behind the intrinsic value of a company, what it means to be a business owner and what differentiates a good business from a great one. Our contention is that there is little or no correlation between short-term stock price movements at the time of earnings reports and long-term success in common stock investing.
Will Millennials Drive in 2-0-1-5?
It is our opinion that the most important question in stock picking is one related to the Millennial group. Will they drive the U.S. Economy in 2015 through 2020 and in the process greatly impact the long-term profitability of the businesses which benefit the most from their emergence?
Are Macroeconomists Rebuilding a Wall of Worry?
Those of you who follow us at Smead Capital Management know that we believe in the idea that good markets die on too much affection and continue due to a lack of affection. You also know that we want to own wonderful companies for a long time and do so through regular stock market corrections/bear markets over the years. Since the stock market bottom in March of 2009, this secular bull market has climbed on a wall of worry and on a lack of optimism.
Where Did The New Middle Class Citizens Go?
The "well known fact" with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have.
Pushback: The Gift That Keeps on Giving
We have been out on the road telling the story of Smead Capital Management and explaining our portfolio of common stocks. One of the many benefits of these meetings is the feedback we get from existing investors, potential investors, the financial media and other interested parties.
Strangers Passing in the Night
The economies of China and the United States appear to be headed in the opposite direction. Chinas economy is decelerating fast and the U.S. looks right on the cusp of having its economic growth accelerate, as evidenced by the revised quarterly GDP number of 3.9% released on November 25th, 2014.
Will $2.50 Gasoline Catalyze U.S. Consumer Stocks?
A great deal has been written about how lower gasoline prices could stimulate discretionary purchases in the United States. RBOB gasoline futures peaked on June 20, 2014 at $3.12 per gallon and closed on November the 14th at $2.04. Those in the bearish camp like Randall Forsyth at Barrons argue that lower oil and gas prices will negate and ruin the economic benefit of the oil boom.
Outrunning the Bear: An Active Managers Survival Guide
Two long-time friends go up in the mountains on a hunting trip. At 4:30 A.M. of the second day, one of the men wakes up at one end of the tent to find his buddy dressing and putting on his running shoes at the other end. He asks him what he is doing. His friend says, There is a bear outside our tent. The other guy exclaims, You cant outrun a bear! His friend replies, I dont have to outrun the bear, I just have to outrun you.
Do Activist Investors Let the Game Come to Them?
As a recovering amateur athletethe pinnacle of my athletic career was four years of Division III college golfone concept became obvious at almost every level of athletic endeavor: let the game come to you. Rather than trying to impose your will on the opposing team or opposing player very quickly, you instead seek to discover your opponents weaknesses and use the duration of the contest to establish your superiority.
Attractive Stocks in a Bifurcated Market
As value stock picking managers, we assume we will be operating in a bifurcated equity environment. We think the bifurcation will be between sectors of the stock market which appear over-capitalized due to rear-view mirror success and those which look undervalued when considering the present value of their future income stream. The combination of numerous forces, both positive and negative, will most likely create this bifurcation.
You Ain't Seen Nothin Yet
Someone recently asked a group of us which band we saw at our first rock concert. My answer was the Canadian band, The Guess Who, in 1975. With hits like No Time, Undun and These Eyes, The Guess Who hit the perfect balance between my 17-year old testosterone driven aggressiveness and my urge to romance the woman of my dreams. The key members of the band in the 1960s and 1970s were Burton Cummings and Randy Bachman.
Warren Buffett on Buying Businesses
Wed like to ask a self serving and much nuanced question: is your active equity portfolio manager buying businesses for you or are they trying to guess what the stock market will do in the next month or few years? Much like Samuel L. Jackson asks, Whats in your wallet? in television commercials, wed like to ask, Whats in your portfolio?
Buffetts Passive Can of Worms
A great deal of confusion exists today about the merits of passive investing as compared to well-researched active management. An added layer of confusion arose in March when Warren Buffett explained that 90% of his widows money would be invested in a low-cost S&P 500 index fund. If this summer was a football game, 15-yard personal foul penalties would be thrown everywhere as experts piled on top of that announcement.
The Myth of Student Debt: Lies, Damned Lies and Statistics
As school season kicks off, we at Smead Capital Management have been perplexed by the logic and reasoning over the student debt debate in America. There is a consensus in the investment markets today believing that student debt is a major credit problem rivaling other credit problems that were disastrous over the last 30 years.
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