Dear fellow investors,
As the chart below shows, investors are demanding as much protection against inflation today as they did in 2011. We will review what investors were thinking in 2011 and explain why their expectations were in error. Then, we will compare today’s circumstances and talk about how we can seek to take the most advantage of the circumstances like we did back then.
In 2010, I was on CNBC’s Worldwide Exchange debating Jimmy Rogers on the subject of inflation. He was convinced that the massive liquidity injected by the Federal Reserve into the U.S. economy during the Financial Crisis would trigger explosive inflation. The extra spread of 2% above inflation on the 30-year TIPS exemplified the consensus at that moment.
Why did that former liquidity from the financial crisis not cause inflation? First, as the money supply grew, the velocity of money declined. Second, we were in a home building depression, which normally would have boomed in a low interest rate environment. Third, the emerging large cohort of adults (millennials) were about to delay adulthood by about seven years compared to prior generations and would postpone household formation. At the same time, the Gen X group was much smaller in size than the prior group (boomers).
The result was the most anemic economic growth following a recession in U.S. history. We argued that the economy was like a game of Monopoly where you doubled the amount of money in the bank. Since they didn’t give the players any more to start the game or more for passing go or more for landing on free parking, it didn’t cause inflation. At Smead Capital Management, we took full advantage of our view and beat the S&P 500 Index in our strategy five years in a row. We did it through buying cheap mature growth stocks that could grow despite the anemic economic growth.
Fast forward to today. The 30-year TIPS are set for high inflation expectations after the most massive, monetized liquidity since World War II. After taking interest rates to nearly zero, the U.S. Government, in two presidential administrations, monetized nine trillion dollars of liquidity and injected it into the economy. In case that wasn’t enough, they did another on the misnamed Inflation Reduction Act.
Back to the Monopoly analogy. This time, they gave the players way more than $2,000 to start the game, paid way more for passing Go and dramatically loaded up the free parking. Stimmy checks, PPP money and forgiven student loan payments might have retarded the behavior of millions of 15–30-year-old Americans in the process. We believe that just to be sure that inflation will be a problem they threw one trillion dollars at uneconomic clean energy projects through what we call the Inflation Creation Act!
Therefore, the inflation protection sought through the 30-year TIPS will pay off in a big way this time, in our opinion! We are loaded with inflation beneficiary stocks like oil and gas stocks and useful real estate. We are banking on the economic activity of that same slow-starting Millennial group to translate into an inflation-driven home building boom as too many people with too much monetized debt chase too few homes. The classic definition of inflation.
We especially like DR Horton (DHI), Simon Property Group (SPG) and Apache Petroleum (APA), as ways to get our share of the profits from a very overvalued stock market. It is a stock market that is priced under the assumption that inflation will abate. Unfortunately, the government is discouraging fossil fuel production, so get ready for high oil prices for a long time. Throw in labor demanding higher wages and you get both cost-push and demand-pull inflation like what we saw in the 1970s. As inflation becomes a decade-long problem, we believe you will see growth stock price-to-earnings multiples contract over time.
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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