Category: Missives

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.

As long-duration common stock pickers we seek to buy meritorious companies which fit our eight criteria for stock selection. However, as investors with a ten-year time frame and 36-years of observational experience in investing, we invoke Bernard Baruch who said, “The activity which made me the most money in common stocks was sitting on my hands.” For this reason, we have an interesting perch to watch the investors around us who are turning their portfolios over with regularity. How does an investor get a feel for shorter duration tops in the one-to-two year time range?

During our discussions with clients in October we were asked repeatedly what the outcome of the Presidential election would do to our investments. Regardless of the outcome, our answer was always the same. In our opinion, whoever was elected in 2016 was going to be the luckiest person to hold the seat since Ronald Reagan. Our belief comes from the emergence of the largest population group forming households like boomers did in the 1980’s.