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The Demise of Active Management is Greatly Exaggerated
Financial advisors and registered investment advisors feel severe pressure to throw in the towel on manager selection methodologies and accept index returns. Yet, many of these stories forget one central concept: indexes are actually inexpensive actively-managed portfolios. Every actively managed fund is an index itself.
Theres No Place Like Home
The Comic-Con convention comes to Seattle every year. The city teams with 15 to 45-year-old folks who love to emulate their favorite comic and movie characters. We have joked lately that we should hire a young woman to dress up like Dorothy from the Wizard of Oz and come with us when we speak in public. Wed have her click her ruby red heals together and say, There is no place like home!
Would John Templeton See Light at the End of Aflacs Tunnel?
As someone who came into the investment business in 1980, I was immediately enamored by the logic of Sir John Templeton. He was the founder and portfolio manager during the first 40 years of the Templeton Growth Fund. During his tenure the fund beat the S&P 500 Index by 2% per year, net of annual expenses. We believe his best concept as a contrarian investor was his idea of buying common stocks at the point of maximum pessimism.
U.S. Stock Market on the “Edge of Tomorrow”
Recently we heard a market prognosticator declare that we could have a 30 percent decline in stock prices in the next 12 months. Presumably because investors fear starting over again, like many did at the market bottom in 2009, the talking head had ample emotion on which to make such a grandiose assertion. This fear of starting over reminded me of the recent Tom Cruise movie, "Edge of Tomorrow," where Tom Cruise plays a soldier forced to live the same day again and again in efforts to develop answers on how to defeat a force which would end the world. Hence, living on the "Edge
2Q 2014 Newsletter: Avoiding Your Portfolios Enemies
Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful. We often hear the last part of this wonderful quote from Warren Buffett, but here at Smead Capital, we find the beginning just as instructive. We thought we would unpack the entirety of his thoughts and dissect it for our faithful investors.
The Internet is Brutally Efficient and Totally Agnostic
On my way home from work recently my progress was impinged by a group of protesters headed up 4th Avenue in downtown Seattle to the headquarters of the Gates Foundation. Bill and Melinda Gates are spending millions trying to figure out how to make the U.S. education system more efficient and successful. Some of their recommendations are thought to damage efforts by the most powerful teachers unions to protect the interests of teachers. The Gates Foundation wants to bring efficiency and seems to understand that they need to be agnostic in their approach.
Forget 2008 While Avoiding Popularity
We continue to be encouraged by the endless interest in doomsday writing about the next 2008 and the way asset allocators have positioned themselves to defend against its possibility. The most popular writers seem convinced dismal returns are in front of us, economic success in the US is impossible and that the next US stock market decline will punish fully-invested common stock owners. It is our belief the next ten years will include two bear markets of over 20%.
The Over-Capitalization Curse
At Smead Capital Management we are conscious of the few, but significant pitfalls which we believe exist for the long-duration common stock investor. One of the main pitfalls we want to avoid is the over-capitalization curse. This is a situation where investor enthusiasm gets very high, prices get historically high and investors drown the company, industry or sector with capital. In our experience, it pays to avoid the over-capitalized areas for as long as five to ten years as they work their way back to being hated and contentious.
I Love Technology, but I Love LaFawnduh More
The first time I saw the movie, Napoleon Dynamite, I walked out of the theater before the final wedding scene. This caused me to miss Napoleons brother Kip singing "Always and Forever" to his new bride, LaFawnduh. The key line in the song was, "I love technology, but not as much as you, you see!" Kip found LaFawnduh "in a chat room," which indebted him to technology.
The Orphaned Bull Market
Howard Gold is an inquisitive writer for Marketwatch.com and we think has done us all a great favor in his latest column titled, Not even a bull market can interest people in stocks. He points out via the chart below thatdespite a huge rebound the last five years in US common stocksequity holdings as a percentage of global investable assets just climbed to levels only seen at major stock market low points. Relative to the past 50 years, this stock market has been abandoned and orphaned even as it had made participants wealthy.
The Investor Screwtape Letters
We at Smead Capital Management have been discussing some of the follies common to human nature and what we see as some pervasive trends in the investing world. These conversations got us imagining what C.S. Lewiss, The Screwtape Letters, might sound like if they were applied to todays investment environment. The satirical letters are written by an advice-giving bureaucrat in Hell named Screwtape, to his nephew Wormwood, a young demon who is learning how to lead humans astray. Taking some liberty with Lewiss work, we present what we believe Screwtape might say if he were tr
Throwing Babies Out With Bathwater
Instead of behaving wisely, we think investors have been "throwing babies out with the bath water" this year. We believe speculators have fled out of the Biotech ETFs and have unwittingly sold Amgen (AMGN) between $129 and $109 per share because it is the largest holding of most of these targeted vehicles. From our vantage point, investors have tossed out EBAY (EBAY) in the internet space, Gannett (GCI) in media, Pfizer (PFE) in Pharma and Bank of America (BAC) and JP Morgan (JPM) in the banking sector.
The 5 Commandments of Warren Buffett and Charlie Munger
Here you will find our review of the 2014 Berkshire Hathaway Annual Shareholder Meeting. As we consider these men pioneers of long-duration common stock investing, we wanted to share what we believe were the best nuggets of wisdom from the weekend.
Strong Insider Ownership: Do as I Do, Not as I Say
At Smead Capital Management, we often get asked if we visit the top management of the companies we research. While we read everything we can and do get exposed to the management of our companies over time, we believe it extends credulity to think that a 15 to 30 minute meeting with a senior executive of one of our firms is going to produce alpha for our clients. And, even if the meetings were useful, is there a single senior manager in the US who would tell us that they have big problems around the bend or that their common stock is immensely over-valued?
A Strong Balance Sheet
In his book, Great by Choice, Jim Collins points out that companies he defines as great have good luck and bad luck just like all the other companies do. The great companies handle difficult circumstances better than good companies and take the most advantage of the breaks they get in business.
Every Portfolio Has Faith
At Smead Capital Management, we believe that everyone who invests has faith in someone or something. We also believe that who and what you put your faith into is greatly influenced by the time period involved. As we look out into the rest of 2014 and beyond, we would like to consider the kind of faith required by the largest pools of investment dollars in the US. This includes looking at who they are trusting, what they are trusting in, and what time frames they are operating under.
Management?s History of Shareholder Friendliness
Many years ago, United Airlines had the slogan, "Fly the Friendly Skies." At Smead Capital Management, we like to own companies for a long time which are "friendly" to their public shareholders. In this missive, we will define what it means in our eyes to be shareholder friendly and give a company specific example of this friendliness.
Available at a Low Price in Relation to Intrinsic Value
At Smead Capital Management, valuation matters dearly. We believe all the academic studies from Fama-French, Bauman-Conover-Miller and Francis Nicholson, show that cheap stocks as measured by price-to-book value (P/B), price-to-earnings (P/E) or price-to-dividends outperform more expensive stocks. We especially love Nicholson?s 25-year study because it shows that the 100 cheapest stocks that make up the lowest P/E quintile see their outperformance expand the longer you hold them. Cheapness is the gift that keeps on giving.
High and Sustainable Profitability
To understand our third criteria for selecting stocks, you need to imagine athletes who have found the fountain of youth. Consider this: Robinson Cano has been one of the most consistently successful baseball players over the last ten years, and the Seattle Mariners just signed Cano to a 10-year contract for $240 million. Companies, however, don't have ten to twenty-year careers, because the average company in the S&P 500 Index lasts 50 years.
Strong Competitive Advantage
Rarely has anything been said about business which is more brilliant. Or at least that?s our take on a quip from one of my favorite movies, O Brother Where Art Thou. In the movie, a music producer showed up at the radio station where the The Soggy Bottom Boys recorded their single, ?Man of Constant Sorrow,? which had become an overnight smash hit. He announced to the blind man running the station, ?We?ve got to find those boys and sign them to a contract before the competition does!? The blind man leans back and says, ?O, yes, we got to beat that competition.?
Meeting an Economic Need
At heart, Smead Capital Management is a stock picking organization. On top of our bottoms-up stock picking discipline, we are driven by our belief and respect for the laws of economics. One example of this is the subject of demographics. As long-duration investors, we want to understand where the aging process is taking demand in major product categories and how it will shape spending and production in the US. In other words, what economic needs will grow at the margin and who out there among companies that fit our other seven criteria can meet that marginal demand.
Harvard?s Endowment: Wise or Foolish?
Warren Buffett says, "What the wise man does in the beginning, the fool does in the end." In a Barron's feature over the weekend, writer Andrew Bary dug into the portfolio of Harvard's Endowment through an interview with their CIO, Jane Mendillo. After all, who could possibly be wiser than what many would argue is the most respected undergraduate and graduate university in the world? Using a combination of Bary?s article and our perspective, this missive will seek to determine whether the Harvard Endowment is wise or foolish.
EM Misery and US Large-Cap Euphoria
Many investors are wondering why emerging stock market misery currently equates to weakness in the US stock market as represented by the Dow Jones Industrial Average and the S&P 500 indexes (large-cap). Long time followers of our writing at Smead Capital Management are aware that we have been making the argument this would happen since 2010 and we are happy to review our thesis.
Do China Insider Transactions Lie?
In our business, we like to say that insider transactions never lie. For this reason, one of our eight criteria for selecting common stocks is strong insider ownership, preferably with recent purchases. Additionally, as contrarians, we want to make our original purchases in a business at a time when most investors are scared to buy for one reason or another. When we see officers, directors and substantial existing shareholders of a business buying at prices which are temporarily depressed, we raise our confidence in the long-term future of a business.
Dreman and Lorde: We Will Never Be Royals
In his 1980 book, Contrarian Investment Strategy, David Dreman opens with an analogy comparing the stock market to a casino with two distinct sides. The "red" room has lots of action and an occasional player striking it rich quickly. In effect, you become royal. Unfortunately, most of the players leave without the money with which they entered, because the house has the odds stacked heavily in its favor.
2014: Once more for '84
by Team of Smead Capital Management,
Since our thinking is always dominated by owning businesses which meet our eight investment criteria in a long-duration time frame, we continue to remain vigilant of the circumstances around us. To that end, we thought it would be helpful to review a similar historical situation and glean a feel for what was wise behavior back then and what might be wise behavior as we look forward to the year 2014.
David (Active Management) vs. Goliath (Passive Indexes)
Malcolm Gladwell is a fantastic writer and his new book, David and Goliath, got us thinking about his current thesis: David as a poster child for underdogs is a mistake. Gladwell contends that David had significant advantages over Goliath. In true Gladwellian form, he incorporates a myriad of disciplines to defend his thesis. And in true Smeadwellian fashion, we would like to add stock picking to the list of disciplines that strengthen Gladwells argument.
The Milken Rule and Wide/Sustainable Moats
This is my 34th year in the investment business. You might not be aware that I trained and worked at Drexel Burnham my first nine years in the business. Michael Milken was the driving force behind the success and profitability of my original firm. What happened to Drexel and Mike Milken in the late 1980s is a study in how to have a brilliant vision and how to handle a business with a very wide moat. Its demise has created what I call the Michael Milken rule and we believe it should be used in present day analysis, in particular when it comes to evaluating moats.
Macro Factors Distract Wealth Creation
What do Obamacare, Federal Government debt/budget deals, Quantitative Easing and jobs data have in common? To us they are all types of macroeconomic factors on which most investors focus. We believe the reason most investors focus on these types of news stories is because they can influence the US stock market over the next six to twelve months instead of the next 10 to 20 years. In this missive, we would like to challenge everyones thinking about their ultimate goal for investing in the stock market and the behaviors which lead to wealth creation.
US Stocks for a Baby Boom
As contrarians, we at Smead Capital Management frequently get questions about stocks like Gannett (GCI), Bank of America (BAC) and eBay (EBAY). To understand how excited we are to own these common stocks you need to understand how a long-duration common stock portfolio would benefit from the coming baby boom in the developed world. Thanks to wonderful research from The Bank Credit Analyst (BCA), we can understand the demographics of developed nations like the US. BCA concluded that a "baby boom" is coming in the US and in other developed nations.
Dream to Outperform the Market
If you dream about investment market outcomes which are already popular in the marketplace, your dreams can turn into nightmares. The Everly Brothers 1958 hit song, All I have to do is Dream tells us a great deal about the long-term posture of investors in late 2013 and how dreams can turn to nightmares. On the other hand, if you dream about an outcome which most experts arent expecting, the rewards can be explosive.
The Underperformance Culprit
Each year we are reminded of the fact that active management systemically underperforms the benchmark. The scorecards come in, and the tally is drilled back into our consciousness. But has the now long-tenured debate of active versus passive offered us much in the way of new perspective over the last several decades?
Even Economists Get Stuck Looking in the Rearview Mirror
Will the US economy grow in an above-average way in the next ten to twenty years or do we need to resign ourselves to an era of anemic economic growth? Two pieces of information came out this week, adding to existing information on the subject and speak to this core debate in the US stock market. The first piece was called Slowing to a Crawl by Jonathan Laing from Barrons.
The Thermometer of the Stock Market
As long-duration owners of common stock, we believe it is the wealth created by the businesses which causes the owners to prosper. We have also been participants in the US stock market since 1980 and are very aware of big swings in enthusiasm for owning common stocks. So we thought it would be helpful to share our opinion on the current temperature of the market. To take the temperature of the market we need to examine the thermometer readings.
Frustrating the Most People
A venerable sage once said, "The markets do whatever they have to do to frustrate the most people." For the long-duration investor, this means that you need to look at what people are invested in to determine where the frustration will come from. Thanks to the Associated Press, we know what the masses have done with their investments in the last five years.
The Death Knell of Global Synchronized Trade
At Smead Capital Management, we believe the interest on September 18th in emerging markets, oil and gold are the last gasps of a dying trend. Our discipline demands that you must avoid popular investments and completely avoid investments attached to a perceived new era. We argue that the international investment markets reaction to Bernankes reprieve on September 18th is proof of a vision we have of the future.
Bernanke's Temporary Reprieve
There is no nice way to state this opinion: the end of Quantitative Easing and the ultimate allowance of the open market to set interest rates will create a grueling multi-decade bear market in US bond investments. Higher rates mean the re-pricing of existing bond instruments to lower prices and the principle risk of longer-dated maturities getting exposed. In 1983, I remember people losing approximately 15% of their market value in one year as Treasury interest rates rose from 11% to 14%, temporarily crushing owners of 25-year tax-free unit trusts.
Dow Changes as a Contrary Indicator
The folks who select the companies in the Dow Jones Industrial Average (DJIA) came out with their latest changes on Monday, September 9, 2013. They removed Bank of America (BAC), Hewlett Packard (HPQ) and Alcoa (AA) from the DJIA. Added to the index were Visa (V), Nike (NKE) and Goldman Sachs (GS). At Smead Capital Management, we are always looking for important psychological clues to human behavior as it pertains to the popularity of common stocks.
Oil Has Too Many Plumbers
Weve never quite understood why most sensible people dont apply the same economic logic to investing that they do to any other business. Take plumbing for example. If your town has 10 main plumbing companies and 10 more move into town, your economic mind tells you that the added competition will drive down profits. On the other hand, if five of the plumbing companies go out of business, profits should rise over time.
Exponential Business Success
At a major conference in November of 2012, the futurist, Peter Diamandis, shared the concept behind his book, Abundance: The Future Is Better Than You Think. Diamandis, a graduate of MIT and Harvard Medical School, has been a thought leader in everything from space travel (International Space University and X Prize Foundation) to the Internet. His concept is simple. He believes that participants in the US economy and US stock market are drastically underestimating the exponential success which comes from the unlimited impact of the Internet and technology.
Forrest Gump Stock Market
After watching "Forrest Gump" for about the thirtieth time recently, I realized that the US economy and US stock market share a great deal in common with Forrest. In this missive, we will be reminded of the journey of a true American folk hero and of the journey back from the abyss the US economy and stock market have made since early in 2009.
Trickle-Up Economics
Major magazines have a history of putting a topic on their cover at the end of a long-term trend. For example, The Death of Equities was a Business Week cover in late 1979, near the end of a miserable stretch in the US stock market. Times recent cover story, The Childfree Life, got us wondering about the economics of childbearing in the US? Does Times cover mark the end of a trend? Can the US economy succeed without homegrown population increases? Will economic success driven by the current demographics in the US trickle down to unemployed blue collar
China's Government Can't Stop the Bust
On a recent trip to Europe we participated in a forum in Milan of five stock picking organizations. Two were from Brazil, one was from Malaysia and one was picking stocks inside China via the Shanghai Stock Exchange. We believe what they said was an enticement to investors for the purpose of getting them excited about stocks in their country. To us, this reveals a great deal about where prices in emerging stock markets and commodities are headed over the next five to seven years.
Fear Capital Misallocation Not Market Cycles
A great deal of time and energy is spent trying to determine when the current bull market in stocks will end. We at Smead Capital Management make no effort to time the stock market because after 33 years in the investment business Ive never found anyone who did it successfully. We do try to avoid capital misallocation and thought you might want to look at the history of the investment asset classes to see how periods of popularity lead to misery and periods of misery lead to above-average returns.
Royal Babies and Economic Growth
On a recent business trip to Europe, we noticedanecdotallya lack of hope in the economic future of Europe. There is a good reason for the lack of hope. Hope, we believe, comes in the form of new life. When all of the austerity being practiced in developed nations around the world is pretty much done, something else needs to happen for economic growth to take hold. At Smead Capital Management, we believe developed economies need rebirth and the birth last week of a son to the Royal family is a watershed event.
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