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Hey, You, Get Off My Cloud
Walmart (WMT) recently made it clear to vendors that they should “get off” Amazon’s Cloud. This was one of two announcements which speak to the competitive landscape of business in the U.S. The other announcement came earlier when Amazon (AMZN) disclosed an agreement to buy Whole Foods (WFM) for $42 per share in cash.
The Only Game in Town
At the end of my freshman year in college (1977), my brother-in-law’s twin brother called me to ask if I wanted to go to the sixth game of the NBA Finals in Portland. I was a huge Trailblazer fan and was thrilled to sit in the top row of Memorial Coliseum, which held 12,665 fans. Not only was it an unbelievable experience for a lifelong fan (the Blazer’s won), but it was even more powerful because professional basketball was “the only game in town.” No other major professional sport (football, basketball, baseball) existed in Portland in 1977 and there is only one in town today.
Mark Twain Says Pile Out
We wrote recently about the huge valuation spread between the 100 most expensive stocks in the S&P 500 Index and the 100 cheapest stocks. All the academic studies we’ve seen show that cheap stocks outperform average and expensive securities despite the bright futures which the more expensive ones are assumed to have.
The Shot Heard Around The World
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.
The Equity Valuation Paradox
Long time stock market participants sometimes talk about having a “feel for the market.” A better way to think about “feel” is that years of experience may help you understand present day situations because of their similarity to a prior situation. We will call on Billy Joel and his song, “You May Be Right”, to teach us on this subject.
Unseen Risks for Investors
As we have mentioned in our recent pieces, investors are very conscious of the seen risks (especially exogenous risks) in the investment markets. Under the assumption that the seen risks are accurate and well known, let’s look at a few of the unseen risks in the stock and bond markets over the next two to three years which could frustrate investors.
Insatiable Demand for Safety
Marketwatch.com writer, Ellie Ismailidou, wrote an interesting article on July 5, 2016 proposing that the drop in the U.S. 10-year Treasury Bond Yield below 1.4% represents an “insatiable demand for safety.” As contrarians, we love these kinds of well-written thoughts as the media makes folks more and more aware of what has worked in the stock and bond markets this year. We thought it would be helpful to put today’s circumstances into a historical context and look at clues for the best possible behavior for investors in the past and in the future.
Tug of War
Many a spring and summer outdoor celebration culminates in a tug of war. It is where an equal number of folks hold onto each end of a long rope and seek to pull the other side across the midpoint line. We believe a tug of war has existed in the US stock market over the last year between two forces which have been pretty equal in force while pulling in opposite directions.
The Day the Globalization Music Died
As a participant for 36 years in the U.S. stock market, I’ve learned to look for watershed events that must be respected by investors. A watershed event is a point in time where a major secular change takes place. Britain’s vote to leave the European Union appears to be one of those events. We’d like to use the poetry of Don McLean in his song “American Pie” to help our readers understand our view.
Stress Test
In the aftermath of the financial meltdown in 2007-2009 and the lending shenanigans ignored by regulators and politicians prior to 2007, the Federal Reserve Board executes annual stress tests on systematically important financial institutions. The ongoing effort includes running the numbers on economic scenarios as bad as the 1930s and includes high capital requirements dictated by regulators. It is soon followed by regulatory approval for the capital plans of the major banks and insurance companies on the list. These "stress tests" have taken center stage for investors in these companies.
The Coming Housing Boom: Millennials in Exile
Much has been written about the factors original to the American generation of adults currently age 21-39. Many of these factors--student loans, marriage later in life, child bearing later in life, the prior era housing bust and fears that we'd become a renter nation--have dominated investors’ attention. We would like to include one more factor(s) into the mix as we give you an update on the coming boom. Millennials, more than any prior generational group, live in exile. We believe this exile living and hesitancy to put down roots has contributed to the slowness of the coming boom and will contribute to its size and duration.
Billy Joel and the Art of Investing
We believe that Billy Joel is perhaps the most preeminent singer/songwriter of the U.S. baby-boom
generation. Art, like Billy Joel’s music, has a tendency to mirror culture and economics. Thanks to his recent tour in the U.S., we were reminded of how four of Billy’s greatest hits speak to our current
circumstances in the stock market and give incredible advice about how to behave as investors over the next ten years.
Warren Buffett on Hyperactivity
Long term readers are familiar with our ownership of Berkshire Hathaway (BRK) shares, as well as our undying respect for Warren Buffett and Charlie Munger. They have few peers among the best stock pickers and capital allocators in U.S. history, as measured by the returns on Berkshire Hathaway over the last 51 years. On April 30, 2016, faithful shareholders gathered as Mr. Buffett and Mr. Munger shared copious and wise advice at the 2016 Berkshire Hathaway Annual Shareholders Meeting. Ironically, almost every topic was connected to hyperactivity. We attended the meeting, and came away with some thoughts that are somewhat contrarian, including some of his views we found disappointing.
Good News in Newspapers?
On March 10, 2000, two wonderful things happened. Tribune Corporation offered $95 cash for each share of Times Mirror Corporation and, in retrospect, the Tech Bubble burst. At the time, we had avoided technology for valuation reasons and saw value names like Times Mirror begging for shareholders. We had the feeling that the prior two years of purgatory for value investors might be ending. It was truly good news.
Wise Beginnings and Foolish Endings: 1Q 2016 Newsletter
The media and most major stock market strategists have been talking lately about beginnings and endings. The S&P 500 Index just celebrated the seventh anniversary of it taking off from its bear market lows on March 10, 2009. We enjoy watching many experts who didn’t participate in the more than tripling of the S&P 500 Index over those seven years comment and make dire predictions about the future. When it comes to negative nabobs, there must be some pretty good money in being the “boy who cried wolf” or the “blind squirrel that finds an occasional nut.”
Portfolio Management: Which Risks to Take
At Smead Capital Management, we make it a practice of constantly reviewing our discipline of stock selection and portfolio management. Like a sports agent compares athletes, one of the ways we do this is to follow competitors with proven track records of success. Many portfolio managers of U.S. large-cap equity funds have had a very difficult time during the last several years in the U.S. stock market. The market has been especially harsh on many high-conviction, long-duration portfolio disciplines lately. What do history and current circumstances teach us about our stock picking discipline?
Toll Bridge Stocks: Don't Just Do Something, Sit There
The floating bridge, which crosses from Seattle on one side of Lake Washington to Bellevue on the other, has been rebuilt and is almost completed. To finance the new bridge, a toll has been placed on its use. The other bridge, the I-90 bridge, requires no toll but takes you much farther out of your way. It is also jammed by cars wishing to avoid the toll. As a result, the floating bridge is a much more attractive option when traveling to Bellevue because there is less worry about losing time to traffic jams.
Political Punching Bags
The United States has one of the most successful biotech/pharmaceutical industries and arguably the premier banking institutions in the world. During the current presidential race, populist politicians on both sides of the aisle have gained a great deal of popularity by turning these two industries into political punching bags.
Berkshire Hathaway Annual Letter: Cheap and Wonderful
At Smead Capital Management, we have great respect for the most successful long-duration investors. Warren Buffett is among those investors. He gives the public access to his thinking in his annual Berkshire Hathaway shareholder letter. In his recent 2015 letter, he reminded readers of a few of the things that should matter most to investors. We at Smead Capital Management like to buy wonderful companies at cheap prices. Buffet’s letter dwells on the need for businesses to be cheap in a wise way. He also reviews what makes a company “wonderful.”
The Waiting is the Hardest Part
During my college years, Tom Petty and the Heartbreakers rose to prominence. Over the decades to come, Tom proved that he is an American original singer and songwriter. One of his top hits, “The Waiting,” provides very good advice to common stock investors (even though he was picking among women rather than stocks).
The Big Long
I recently saw the movie, The Big Short. While the movie entertained as much as the book, the movie’s release coupled with the rough start to the year probably left a lot of investors feeling anxious. As long-duration common stock owners, we at Smead Capital Management believe a review of the circumstances preceding the financial meltdown of 2007-2009 and a comparison to where we are now in the U.S. economy would be helpful. Since residential real estate was the centerpiece of the movie, and traditionally is a centerpiece of our economy, we will dub our current view as "The Big Long."
Revenge of the Nerds
In a classic 1984 film, “Revenge of the Nerds,” a group of out-of-favor college students (“nerds”) assert themselves at the expense of highly-esteemed fraternity athletes and popular sorority girls. Here is how imdb.com describes the movie on their website:
“At a big campus, a group of bullied outcasts and misfits resolve to fight back for their peace and self respect.”
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.
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%.
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.”
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.
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.
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