William Smead
Chief Executive Officer
Chief Investment Officer

Dear Fellow Investors:

Ten-Year US Treasury Yield since 1/1/1871 

My career started as a stock brokerage trainee at Drexel Burnham Lambert in 1980. As you can see in the chart above, interest rates at that time were the highest they’d ever been in the history of the United States. Businesses were starved for capital and the earnings yield on the US stock market (inverse of the PE ratio) hit a peak of 14.37% in 1980. Unemployment peaked at 10.8% and stockbrokers gathered around the Dow Jones Newswire machine on Thursday afternoon to find out what the M1, M2 and M3 money supply figures were the previous week. Our economic problems seemed unsolvable and a raft of very bright macroeconomic thinkers told us it was only going to get worse. The problem then wasn’t the existing amount of household debt which was inhibiting the economy; it was the absolute cost of borrowing money which held back economic growth in America.

One of the S&P 500 sectors most damaged by the high interest rates was the utility sector. The highly- regulated and highly-leveraged companies were trapped between rising commodity prices, squeezed customers and incredibly high interest rates on their corporate debt. The utility business is capital intensive with a capital I. AAA utility bonds yielded as much as 14%. The dividend and earnings yields on utility stocks was substantially higher than the rest of the market. The spread was the largest it had been since the post WWII period. In 1981, the NYSE new lows list was littered with utility stocks.

The need for capital in this highly-regulated industry forced the hand of the US Congress. They passed a law which allowed investors to reinvest their utility stock dividends and get the first $2,800 of reinvested dividends each year tax-free. Hardly anybody wanted these stocks despite the tax incentive, because of the pervasive fear of losing on negative price movements.

You might be wondering why we at Smead Capital Management bring this up. Today appears to be the antithesis of that circumstance. Capital, as measured by short-term and long-term interest rates, has never been less expensive in my lifetime. For those who are credit worthy, credit has never been cheaper and more abundant.

This helps you understand why our best choices for US long-duration common stock picking avoid these capital intensive sectors. They are the utility, telecom, industrial, basic material and energy sectors of the S&P 500 index. They are massive capital eaters and have enjoyed an amazing cheapening of the cost of eating capital. As interest rates rise over the next ten to twenty years, we believe their profit margins will be crimped by the higher and higher cost of capital and their price-to-book value and price-to-earnings ratios should suffer as a consequence.

We believe the winning sectors in a rising interest rate environment era are companies with little or no debt that generate high levels of free cash flow. This hits at the heart of our eight proprietary criteria for stock selection and gives us great comfort for the future.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

We Advise Investors

Sign up to get our advice sent straight to your inbox.

Recent Missives

The Great Conflagration

February 21, 2024

We consider Ben Bernanke to be the father of 21st-century central bank policy. His work in dealing with the credit crisis in 2008-2009 was just the right policy at that time. The problem...

⟶ Keep Reading

Drivers and Stock Pickers

February 13, 2024

In studies, 90% of drivers think they are above average. We believe that 100% of the people who pick stocks for a living think they will be above average. Is being above average...

⟶ Keep Reading

Business Insider: Cole Smead, CFA on the Potential Fed Policy Decision and Stock Market Failure

February 2, 2024

  The Fed risks making a big policy mistake this year that could spark a 30% drop in the stock market, portfolio manager says By Jennifer Sor For more information […]

⟶ Keep Reading

Chronological Snobbery

January 30, 2024

C.S. Lewis coined the term ‘chronological snobbery’. According to Lewis, the definition of chronological snobbery is “the uncritical acceptance of the intellectual climate of our own age and the assumption that whatever has...

⟶ Keep Reading

Stock Market-Interest Rate Rhymes

January 23, 2024

Warren Buffett regularly reminds his shareholders that interest rates are a gravitational pull to stock prices. History shows that the movement of stock prices and interest rates don’t necessarily happen simultaneously but play...

⟶ Keep Reading

4Q23 International Value Strategy Newsletter: Recognizing Change

January 15, 2024

As we end 2023, the world looks very different than it did a few years ago. The one thing inevitable in life is change. As investors, we are required to spend a lifetime...

⟶ Keep Reading

We Advise Investors

Sign up to get our advice sent straight to your inbox.

US INVESTORS

Individual Investors

OR

Financial Advisors, Family Offices,
and Institutional Investors

OR

NON-US INVESTORS

Individual Investors

OR

Financial Advisors, Family Offices,
and Institutional Investors

OR

Scroll to Top