Category: Missives

What should long-duration common stock owners like us do with the news of the horrific flood in Texas, the Category 5 hurricane in the Caribbean, the heightened tensions created by North Korea’s Dictator, Kim Jong-un, and the 8.1 magnitude earthquake in Southern Mexico? What is wise behavior in a more volatile stock market environment created by outside events? More than 30 years in the industry have taught us that outside events come and go, but patience matters. Just look at the similarities with Billy Joel’s 1989 hit “We Didn’t Start the Fire.” The song named 100 major people, political and economic events in the first 40 years of his life. As you can see, it is interesting how the same subjects continue to pop up in the 38 years since the song hit the top of the Billboard charts.

Forbes article of July 1974 profiled John Templeton, and highlighted some of the wisdom he implemented in his investment process. The article touched on his discipline of consistently praying to God “for wisdom and clear thinking” at the start of each directors meeting for the Templeton Growth Fund. John Templeton noted that even with prayer they still “make hundreds of mistakes, but we don’t seem to make as many as others.” In the article, Templeton also advised that the “ninety-nine percent of investors shouldn’t try to get rich too quickly; it’s too risky.” He advised, “Try to get rich slowly.” Sir John Templeton is on nearly every short list showcasing the most successful investors of all time, and certainly held in high esteem among value and contrarian managers like us.

During the most-recent Berkshire Hathaway Shareholder Meeting, Warren Buffett and Charlie Munger re-iterated a point during the question and answer portion that has stuck with us. We feel compelled to share what we learned.

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.

Like a good attorney, we rarely ask a question for which we don’t have the answer. In the case of looking at sentiment in the economy and in the stock market, we like watching to get a feel for what our professional and individual investor clients are going through to see if it matches what we are hearing and seeing. The bifurcation in the economic sentiment surveys is that sentiment and confidence in economic growth are high, but those enthusiasms have yet to show up in real Gross Domestic Product (GDP) growth.

In September of 2010, we argued that oil prices were trading on psychology and entrenched beliefs, and could possibly have a real price of $10 per barrel. Investor bullishness was driven by the belief in peak oil theory, the slow transition to electric and hybrid engines, and the use of the commodity oil as an investment in the China boom. We were early, but after topping out at $115 per barrel, WTI crude oil dropped like a lead balloon to as low as $29.42.

At a recent industry conference, we were confronted by a chart, a presentation and a song. In early 2017, we find ourselves in an investment world where the merit of stock picking and “active” portfolio management are challenged regularly, which has contributed to a mass exodus of assets from “active” funds to low-cost index portfolios. Is there a place in this world for long-duration, concentrated portfolio management as practiced by Smead Capital Management?

We are great admirers of the writing of the elite business publications like The New York Times and The Wall Street Journal. They recently stepped into one of our favorite subjects, technology company hegemony, which has developed in the business world in recent years. Here is Webster’s definition of hegemony:

Hegemony. 1 : preponderant influence or authority over others : domination 2 : the social, cultural, ideological, or economic influence exerted by a dominant group.

Over a three-year time period, stock prices tend to mean revert. This has spawned numerous investment approaches which try to squeeze capital gains out of those reversions. Classic deep value investing, as popularized by Benjamin Graham at Columbia Business School, taught that you would succeed by buying fifty-cent dollars and selling them when and if they reverted to the mean. The “Dogs of the Dow”strategy of buying the ten highest yielding Dow stocks was born out of mean reversion.

We at Smead Capital Management are in the camp of long-duration investors who believe we’ve entered an extended period of intermittent interest rate increases, a reversal from the 35-year era of intermittent declining rates we have experienced since 1981. The following chart shows that speculators have placed very heavy bets on rising interest rates in November. The placement of these heavy bets indicates that we could be close to the first temporary peak in the 10-year Treasury bond moving from the historically low rates around 1.5%. It looks to us like the first inning of a nine-inning game; the last game of this kind lasted 30 years.