Printable Version

“Locke differentiates three types of law: 1) the law of opinion, 2) civil law, and 3) divine law (see fig. 7.1). The law of opinion refers to general precepts established by public opinion. It is the “law of fashion,” which may merely reflect what is in vogue or what is a group’s collective preference. In modern parlance we may call this “contemporary community standards.”
— The Law of Fashion, John Locke

Dear fellow investors,

The great philosopher, John Locke, brilliantly captured the way the world works. Little did he know that he would also explain how the stock market works, even though it barely existed when he came up with his philosophy. The stock market is driven by “the law of fashion, civil law and divine law.”

Law of Fashion

We have participated in the stock market since 1980 and we know quite a bit of the history of the prior decades. Each decade seems to have its own law of fashion. This means a “general precept established by public opinion.” It is the heart and soul of what John Kenneth Galbraith called “financial euphoria.” In the 1960s, the space race encouraged excitement about “Go-Go” growth companies. In the early 1970s, it was a group of 50 stocks (the Nifty-Fifty) which seemed to grow consistently and were rewarded in the marketplace of investors with highly fashionable price-to-earnings (P/E) multiples.

By 1981, stocks had done horribly as inflation soared and fashion surrounded businesses which benefitted from inflation. Five of the six largest cap companies were oil stocks and energy made up 29.5% of the S&P 500 Index. Oil, real estate and gold enjoyed the favor coming from the “law of fashion.”

In 1998-2000, the Dotcom Bubble controlled what was fashionable in the aftermath of the establishment of the internet, capping an amazing decade of success. Energy got back on its horse from 2000-2011, as the financial crisis boiled and China’s growth dominated what was popular. The last decade (2011-2020) has been the FAANG Era (Facebook, Amazon, Apple, Netflix and Google/Alphabet), as the dominant tech companies have reasserted themselves in the stock market. This is under the general precept that nothing can go wrong with them and how dependent we have all become on their products.

Civil Law

Occasionally, the U.S. government decides to get involved in the stock market via “civil law.” The Sherman Antitrust Act of 1890 broke up Standard Oil in the early 1900s, regulated the railroads and the telephone behemoth (AT&T), sued IBM in the 1960s, Microsoft in the 1990s and is preparing to go after Amazon, Google, Apple, Facebook and others. Here is the chart of IBM in the aftermath of running into “civil law” in 1969, when the Justice Department sued them and sought to break them up:

We have a rule when it comes to civil law in the stock market. When Senator Elizabeth Warren and Senator Josh Hawley agree on something, expect there to be civil law problems for the targets of their jointly held ire. Did I forget to mention Lina Khan, the head of the Federal Trade Commission, who is coming after the FAANG companies?

Divine Law

To us at Smead Capital Management, there are some divine laws which govern the stock market over long time periods.

  1. Interest rates are like gravity to P/E ratios (Warren Buffett)
  2. Euphoric episodes end badly (Galbraith)
  3. Cheap stocks outperform expensive stocks over long time periods (Benjamin Graham)
  4. Performance is enhanced by buying extreme pessimism (John Templeton)
  5. Every stock which goes up 10-fold had to double and quadruple first (Smead)
  6. Young people who buy stocks on borrowed money lose (Edwin Lefevre-Reminisces of a Stock Market Operator)
  7. Most investors suffer stock market failure (Dalbar)

The goal of our work is to avoid getting stuck as fashion disappears. We have no urge for getting beat up by our companies suffering from civil law moving against them. We enjoy using these divine laws to run our portfolios. Thanks to John Locke, we hope to avoid stock market failure.

Warm regards,

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.

©2021 Smead Capital Management, Inc. All rights reserved.

This Missive and others are available at www.smeadcap.com.

We Advise Investors

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

Recent Missives

Cole Smead, CFA at the 2024 London Value Investor Conference

June 19, 2024

Cole Smead, CFA presented “Fossilized Value in a Crazy World” at the 2024 London Value Investor Conference For more information go to www.valueinvest.com. The information contained in this article represents […]

⟶ Keep Reading

The Genesis of Our Stock Selection

June 11, 2024

We have gained a number of new investors and get regular vetting interest from investors who need to understand the roots of our stock-picking discipline. Our stock-picking discipline is built around our eight...

⟶ Keep Reading

The P.A. Conflict

June 4, 2024

[...] We should want customers of the investment industry to get good outcomes. Good outcomes come from good processes and aligned incentives. With US markets being the rage of the investment world, we...

⟶ Keep Reading

Bill Walton’s Insane Brilliance

May 29, 2024

[...] What Bill called “everyone thinking alike” we call a well-known fact. A well-known fact is a body of economic information that is not only known by all market participants but has been...

⟶ Keep Reading

Only Dave Cuts the Federal Budget

May 21, 2024

Back in 1993, a brilliant satirist by the name of Ivan Reitman produced a movie called "Dave." It was the story of a life-threatening stroke besetting the President of the United States of...

⟶ Keep Reading

Buffett and Munger Mark the End of An Era

May 7, 2024

At the Berkshire Hathaway Annual Meeting we marked what we believe is the end of an era both for Berkshire and for the S&P 500 Index. In Berkshire’s case, it is the loss...

⟶ 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