2Q24 U.S. Value Strategy Newsletter: Avoiding the Crowd

Printable Version

The Federal Reserve Board reported its most recent Z-1 on household assets. It revealed that households directly own 27% of their assets in common stock and indirectly own 13% through funds/ETFs/401ks. They also have 14% of their household assets in defined benefit programs, which are currently 50% invested in common stocks. Add it all up, and you get 47% of household assets held directly and indirectly in common stock.

These statistics are dominated by ownership of the most popular stocks as represented by the 10 largest cap stocks in the NASDAQ 100:

The chart below appears to be a very effective thermometer of where we stand on this subject. It compares the performance of the NASDAQ 100 companies to the NASDAQ Composite made up of 3,351 companies (at the time of this writing):


Source: Bloomberg. Data for the time period 1/1/1985 – 6/3/2024.

There is either a generational change in the behavior of common stock participants or a bubble in these most popular stocks. To examine this, let’s start by making the generational change argument. Our economy is dominated by network-effect businesses that were spawned by the fact that technology and the internet have changed our lives. Those who argued that case would say this is the kind of natural outcropping that happened in the past when the automobile and radio business developed and caused stock ownership to be dominated by oil companies spun out of Standard Oil, the largest automakers (Ford, General Motors, etc.) and RCA in the 1920s. There was no NASDAQ back then!

Their argument could have been made in 1969, at the peak of the Go-Go 1960s, when IBM, Xerox, and Kodak dominated common stock ownership. The following chart shows that the largest companies were a bigger part of a broad market index in the 1930s and the 1960s than in the period from 1975 through 1993, which lasted until about 2017.

Therefore, if history is any indication, there is a realistic argument that the concentration in the NASDAQ 100 can get higher before it breaks. The highest concentration over the last 60 years was in 1963, and stocks didn’t break until the end of 1968. Therefore, a pretty good argument would say that you can stay at a high concentration level for a number of years.

Prior to the last 10 years, the highest concentration in the S&P 500 Index among the top ten stocks was in 2000. The combination of COVID-19 shutdowns and the monetization of $11 trillion in Federal debt by two presidential administrations has helped inflate the stock market and forcibly raised concentration in the S&P 500 Index today.


Source: JPM Asset Management Data for the time period 1/31/1996 – 6/3/2024.

We like to say that you can’t hold your breath until this euphoria episode breaks! However, we are in the Charlie Munger camp when it comes to richly priced and extremely popular stocks:

My foregoing acceptance of the possibility that stock value in aggregate can become irrationally high is contrary to the hard-form efficient-market theory that many of you once learned as gospel from your mistaken professors of yore. Your mistaken professors were too much influenced by “rational man” models of human behavior from economics and too little by “foolish man” models from psychology and real-world experience. Crowd folly—the tendency of humans, under some circumstances, to resemble lemmings298—explains much foolish thinking of brilliant men and much foolish behavior, like the investment management practices of many foundations represented here today. It is sad that today each institutional investor apparently fears most of all that its investment practices will be different from the practices of the rest of the crowd.

Munger said that envy is a lousy sin because it’s the only one you could never possibly have any fun with. Therefore, we will ask you to sit through any underperformance that occurs until history catches up to these glamorous common stocks. We will stick to our eight criteria and our value discipline and expect to get well rewarded whenever this episode ends, as we have following other difficult popular markets.

Fear Stock Market Failure,

_______________________________________________

The recent growth in the stock market has helped to produce short-term returns for some asset classes that are not typical and may not continue in the future. Margin of safety is the difference between the intrinsic value of a stock and its market price. The price-earnings ratio (P/E Ratio or P/E Multiple) measures a company’s current share price relative to its per-share earnings. Alpha is a measure of performance on a risk-adjusted basis. Beta is a measure of the volatility of a security or a portfolio in comparison to the market. FAANG is an acronym for the market’s five most popular and best-performing tech stocks, namely Facebook, Apple, Amazon, Netflix and Alphabet’s Google. Growth investing is focused on the growth of an investor’s capital. Leverage is using borrowed money to increase the potential return of an investment. Momentum is the rate of acceleration of a security’s price or volume. The earnings yield refers to the earnings per share for the most recent 12-month period divided by the current market price per share. Profit margin is calculated by dividing net profits by net sales. Quality is assessed based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability). Value is an investment tactic where stocks are selected which appear to trade for less than their intrinsic values. The dividend yield is the ratio of a company’s annual dividend compared to its share price.

The information contained herein represents the opinion of Smead Capital Management and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice.

Smead Capital Management, Inc.(“SCM”) is an SEC registered investment adviser with its principal place of business in the State of Arizona. SCM and its representatives are in compliance with the current registration and notice filing requirements imposed upon registered investment advisers by those states in which SCM maintains clients. SCM may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements. Registered investment adviser does not imply a certain level of skill or training.

This newsletter contains general information that is not suitable for everyone. Any information contained in this newsletter represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. SCM cannot assess, verify or guarantee the suitability of any particular investment to any particular situation and the reader of this newsletter bears complete responsibility for its own investment research and should seek the advice of a qualified investment professional that provides individualized advice prior to making any investment decisions. All opinions expressed and information and data provided therein are subject to change without notice. SCM, its officers, directors, employees and/or affiliates, may have positions in, and may, from time-to-time make purchases or sales of the securities discussed or mentioned in the publications.

This Newsletter and others are available at smeadcap.com

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