Category: Missives

As an observer of ten presidential election cycles while working in the investment business, we thought it would be a good thing to give the current stock market environment some historical context. Revenue growth stories in tech are making what some would call “maniacal new highs.” Perceived losers in the 2016 cycle, like healthcare, have been purged by the stock market. Betting sites and many of the polls have had Hillary Clinton running ahead (before the reopening of the FBI investigation) and favor among the S&P 500 sectors is seemingly representative of her perceived industry likes and dislikes. Could this discounting prior to the election be symptomatic of a contrary indicator?

John Maynard Keynes introduced the concept of “animal spirits” as it relates to economic activity in his 1936 book The General Theory of Employment, Interest and Money. The term “animal spirits” is a way to describe what drives human behavior to consume, take risk and engage the instinctual proclivities that are natural to economic living. This important piece of Keynes’s work came seven years after the Great Depression and we think the concept is critical to understanding the economy and markets of today, eight years after the biggest recession since the period he was addressing.

As a young stockbroker in the 1980’s, I was hungry for disciplines which could help me make money for clients. One of the most sensible things I came across was a theory by an investor that we refer to as the 70-20-10 rule.  Human nature dictates an urge to make money in stocks quickly and for me that was proving to be difficult and problematic. Hence, the hunger to learn from theories like this rule.

Any avid climber must be deeply anxious while watching the movie, Everest, a true story based on a 1996 expedition to the summit of Mount Everest. This gripping story, from a memoir called Left for Dead: My Journey Home from Everest, follows a climbing team whose journey turned disastrous from dealing with the naturally volatile conditions on Mount Everest.

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.

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.

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.

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.

As we enter April, baseball comes to mind while the Major League Baseball Season begins. Commissioner Giamatti’s thoughts are apropos and reflect on baseball across the seasons of the year for players and the fanatics of the sport. Baseball carries many similarities to investing. There are a myriad of investment opportunities among stocks, bonds and other investment products much like there are thousands of events in a baseball season like plate appearances, outs and runs. The one constant in the investment world and baseball is change. Change during the year. Change over the years.

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 competitiors 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?