Dear fellow investors,
In the time since COVID-19 hit the economy and stock market, there has been three phases. First, the question was ‘when’ will the economy return to pre-COVID normal? Next came ‘sooner or later’? Recently, we have moved to ‘will the economy ever come back’? For long-duration investors like us, what are the investment implications in where we are now in a U.S. stock market with many securities priced for ‘never’?
When COVID-19 hit in February, centered in the media capital of the universe (New York City), all hell broke loose. The S&P 500 Index fell 36% the fastest in history and value investors owning economically-sensitive stocks fell even more. Those of us with knowledge of history began to establish when the economy might recover from a government-dictated crushing. Therefore, the first question was, “when?” Most investors were betting on six months or twelve months or a year and a half.
When pessimism reached a series of pinnacles in late March and early April, even 18 months looked like a good risk-reward relationship for bombed out companies with long histories of success. By June 8, it looked like mitigation would cause normality sooner than 18 months and economically-sensitive stocks rallied for that reason.
Unfortunately, we had the biggest super-spreader events (protests) in cities nationwide than we have had for decades, and a new surge took place led by Miami, Houston, Los Angeles and Phoenix. When ‘sooner’ died and was replaced by ‘later’, the stock market went crazy on COVID-19 misery beneficiaries like the FANMAG stocks.1 Economically-sensitive stocks went back into the full-blown doghouse! We then saw the most extreme reading between growth and value go from terrible to freakishly worse than the Nifty-Fifty episode and the Dot-Com Bubble.
Now that the misery beneficiaries have wowed investors with massive profiteering, they have seen their shares go into an additional stratosphere! We read and hear strategists and analysts proclaiming that what we do during this forced shutdown will be what we will do when COVID-19 becomes history. In other words, the economy will never normalize and we will just be people who exist to lace the pockets of the FANMAG companies and their shareholders.
While you are considering this, investors are bailing out of the best relative risk-reward relationship since 1963 for investors who demand assets, profits and free-cash flow from owning businesses. A recent UBS study (via the University of Maryland) shows that value is in the 100th percentile of those 57 years. All prior growth stock popularity episodes pale in comparison to this gap. Their study showed that value is so depressed that even if it stays at 100th percentile, value would beat the S&P 500 Index over ten years. If we revert to the historical mean, value would beat the index by 5% per year compounded over ten years or 68% counting compounding.
For this reason, we believe the risk-reward relationship for value among long-duration investors will never be better. Think of it like this. Value being out of favor causes energy and banks to be very depressed. Chevron (CVX) just used this relative value in acquiring Noble Energy and Warren Buffett is backing up the truck buying depressed Bank of America (BAC) shares.
Buying Bank of America in the open market recently, with the right to own up to 24.9% of the company, is a ‘when’ purchase. At his early May virtual Berkshire Hathaway Annual Meeting, Buffett had concluded that the airline industry, for him, will never normalize. For those of us who are long time Buffett admirers, that is a huge pivot. Berkshire Hathaway also recently acquired Dominion Energy. Putting two plus two together, the wisest investor of all time is buying in the value sector.
Who do you want to emulate? Equity strategists and analysts, who are in universal agreement that we will never return to normal, are paid to have an opinion and are under pressure to conform? Since there is no such thing as normal, we like the odds provided by these economically-sensitive and economically-critical companies at these prices. Even growth investors know to never say never! We are stock market investors in wonderful companies, and we approve of this message.
1FANMAG stocks include Facebook (FB), Amazon (AMZN), Netflix (NFLX), Microsoft (MSFT), Apple (AAPL), and Alphabet (GOOG) (formerly known as Google).
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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