Dear fellow investors,
Karen Carpenter was one the greatest singers of my lifetime. One of her biggest hits was called, “Top of the World.” The key line of the song says, “I’m on top of the world looking down on creation and the only explanation I can find, is the love that I’ve found ever since you’ve been around, you most put me at the top of the world!”
The great Vanguard Windsor manager John Neff used to say, “When you want to brag about a stock, you ought to sell it.” What has been happening lately in our interactions with our current and potential investors all around the world is startling. Asset allocators are repeatedly telling us that if they sold any of their core position in the S&P 500 Index, they would get fired by their customers. In other words, the S&P 500 Index is “on top of the world!”
A little history is in order on this subject. A very smart man at Vanguard (yes, the same Vanguard as John Neff) named Jack Bogle figured out that for most stock market investors, it was foolish to try to beat the stock market return. Vanguard acted on this by creating the first fund which owned the S&P 500 Index. The diversification of owning 500 stocks and the low expense ratio has been a winning combination for decades. Today, there is approximately $1.3 trillion in just Vanguard’s fund and ETF version of the S&P 500 Index.
Unfortunately, every good investment discipline becomes problematic if it gets universally adopted and/or over-owned. The late one-time leader of Intel in its glory days, Andy Grove, was quoted in Fortune magazine as saying the best business advice he got from his professor at the City College of New York was this: “When everyone knows that something is so, nobody knows nothing!” What is it that everybody knows?
When my fellow portfolio manager, Cole Smead, was in Bangkok recently, he was told by a number of very large institutions in meetings that they would get fired if they sold any part of the S&P 500 Index holding. When I was in Zurich recently, more than one major asset allocator told us the same thing. Our sales team repeats that sentiment in every geography in the U.S., and many times, we are told this live on update calls.
How has this come to pass? First, interest rates went down sharply from 1981 to 2021:
In theory, as the cost of capital declined, investors became willing to pay much higher prices for common stocks in the S&P 500 Index. Ironically, as you can see in the above chart, when rates rebounded, it didn’t have its usual sustained impact on stock prices.
Second, despite some jarring interruptions, the S&P 500 Index has had the most spectacular 44-year run in U.S. history. With record company concentration in the S&P 500, momentum has become the only major factor in factor investing that has worked the last 15 years as the Index produced 14% compounded per year returns.
Third, on top of the index success has come record participation from individuals and institutional investors in the U.S. and around the world:
Lastly, the U.S. common stock market cap as a percentage of worldwide stock market cap has broken every record. The MSCI All Country World Index composition is currently comprised of 65% U.S. stocks and only 35% in the rest of the world.
In conclusion, we are contrarians and are therefore happy to pursue quality companies that haven’t received the affection from this historical momentum. Remember, Japan was on top of the world in 1990 and China was on top in 2011. They were exceptional back then and were receiving “the love that I’ve found” from investors worldwide.
Fear stock market failure,
William Smead
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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