Category: Missives

My career started in 1994, which was a stealth bear market for stocks and an outright bear market for bonds. Fed Chair Alan Greenspan hiked rates seven times as he played catch up in response to a percolating economy that rediscovered its sea legs coming off the 1991 recession. The Federal Funds Rate doubled from 3.00% to 6.00%, and the 30-year bond yield jumped 150 basis points to 7.75%. You lost roughly 25% by owning the long bond, and although the S&P 500 grew operating earnings 18% that year, its price declined around 1.5% while your average stock did far worse. This Fed era was quite opaque, often surprising the market and offering very little read-through. At times it seemed Greenspan reveled in non-transparency, as the opening quote reminds us.

We consider ourselves excellent spectators of competition and look forward to March Madness this month. We are reminded that these very competitive games can’t take place unless there are rules and referees to officiate. Our long-time readers are aware that we have warned of the danger surrounding the aggregation of power by the monopolistic tech behemoths. In the last week, March 11-17, 2019, everyone from Senator Elizabeth Warren to The Wall Street Journal editorialist, Andy Kessler, to Arizona State Attorney General, Mark Brnovich, have weighed in on the subject of the rules surrounding competition in business and who should be officiating. We would like to reexplain our position on this subject, because we believe it is a most critical question in U.S. long-term economic success, in economic inequality and in where to invest in the U.S. stock market.

Financial euphoria episodes are a common occurrence in investment markets and the U.S. stock market. When a new one comes along, market participants accelerate their enthusiasm toward the end, which makes the shares of companies involved dead to us. The new mania becomes comparable to prior episodes and prepares to destroy the capital of those who extrapolate the existing trends and enthusiasm.

The market hates ambiguity. That’s what we’re told, and on any short-term basis, we can see the market vote accordingly. In a world where investing has morphed towards algorithmic trading systems influencing daily volatility, many have come to accept this as a reasonable truth and participate by selling when things lose clarity or piling in when visibility is perceived.

We are revisiting our discussion of what the real world is like versus what academics claim in papers and debates. A good way of putting this is “Academia has a tendency, when unchecked (from lack of skin in the game), to evolve into a ritualistic self-referential publishing game.” In 1984, this is exactly what Michael Jensen did in his talk at Columbia University in a debate with Warren Buffett. We know that reciting more and more of your colleagues’ papers is the best way to win in academia. We seek to finish this discussion on what works in the real world.

In preparation for a talk, I began to review Sir John Templeton’s track record with the Templeton Growth Fund (TEPLX), which he managed from 1954 to 1991. At the age of 34, with a father that broke into the investment business in 1980, I was very aware of Templeton’s success in his career, but unaware of how the results came to his clients. What you walk away with after reviewing his track record is the knowledge that very few people in our industry (particularly academics) are conscious of what it took to produce that success. After Templeton, we also reviewed Sequoia Fund (SEQUX) from inception to date. We walked away thinking that the ride that the investors had with these vehicles wasn’t the most important part of the experience, it was the results. Academia says otherwise. We will unpack this.

Our long-time readers are aware that we analyze the U.S. stock market through the prism of what we call “well-known facts.” A well-known fact is a body of economic information which is pretty much known to all market participants and has been acted on by almost everyone with available capital. Former Intel CEO Andy Grove use to say, “when everyone knows something is so, nobody’s knows nothin’.” Today there are several well-known facts which we believe are leading investors down a destructive path.

Investors have called their five-year love affair with technology stocks into question over the last 35 days. For this reason, we at Smead Capital Management are calling in John Lennon and Paul McCartney’s beautiful ballad “If I Fell” to help answer the following questions. Should investors continue to fall in love with these glamour growth titans? How have past love affairs with tech ended? Where might the bottom be over the next five years if history is any guide? Lastly, how will agnostic index and ETF investors react if the stocks which made their wealth grow the last five years become a source of financial heartache?

Most people tend to see what’s right in front of them, especially when it comes to housing affordability. Consider that most of the media organizations in the U.S. reside in the expensive coastal cities. These cities are suffering a decline in home values and contributing to a discussion on what higher home prices and higher interest rates could do to the number of new homes built nationwide. An examination of the laws of supply and demand are essential to this discussion, as well as a review of human behavior in markets based on affordability. We remind ourselves that coastal cities—like our own Seattle—are the exception, not the norm.

In 1720, the South Sea Bubble arose from what seemed to be good intentions. The South Sea Company was given an exclusive monopoly on the Spanish Americas in exchange for assuming a large part of England’s debt. The debt holders received preferred shares in the South Sea Company that paid 6% interest. The business operators of the South Sea Company seized on their de-facto government backing to continue offering shares to pay off all the country’s debt.