4Q20 Newsletter: Outlook 2021: “Frenzy” is the Opposite of Bull Market Stew

Printable Version

Our outlook for 2021 is formed by the need to get away from the crowd and to expect some very stormy weather in the U.S. stock market. We are not afraid of drowning. Therefore, we will review the circumstances at the bottom of the market in 2009 with today’s market to see where the crowd is and where we need to go to avoid the coming storm.

At the bottom of the stock market in early 2009, we worked off the premise that long-term bull markets get their fertilization from the ashes of the prior debacle. In other words, if you wanted bull market stew, you had to have certain ingredients. Recently, the venerable Charlie Munger (of Berkshire Hathaway fame), shared that he thought the stock market is in a “frenzy.” This “frenzy” has caused a huge crowd to form around the most popular stocks and the most popular ways of accessing those popular stocks. To us, this appears to be a nearly complete opposite to 2009. You can almost smell the upcoming stock market failure!

“Again Jesus began to teach by the lake. The crowd that gathered around him was so large that he got into a boat and sat in it out on the lake, while all the people were along the shore at the water’s edge.” (Mark 4:1)

“That day when evening came, he said to his disciples, ‘Let us go over to the other side.’ Leaving the crowd behind, they took him along, just as he was, in the boat. There were also other boats with him. A furious squall came up, and the waves broke over the boat, so that it was nearly swamped. Jesus was in the stern, sleeping on a cushion. The disciples woke him and said to him, ‘Teacher, don’t you care if we drown?’” (Mark 4:35-38)

Stocks did very poorly in the prior ten years

Source: WSJ Market Data Group. Data for the time periods 1/1/1970 – 12/31/1982 and 1/1/1997 – 3/31/2009.

Today, the look-back numbers are as positive as they ever get. This provides no margin of safety to S&P 500 Index investors and is a polar opposite of 2009.

Source: Bloomberg. Data for the time period 3/9/2009 – 11/13/2020.

This ranks among the three best stretches for the S&P 500 Index since 1924. Munger calls it a “frenzy,” which, by definition, is worse than a mania or a euphoria because it is closer to rage and insanity.

Historically depressed stock prices, especially among the traditionally most admired companies

Data for the time period 1/1/1982-12/31/1982.

Source: Barron’s. Data as of 9/30/2020.

Source: Seeking Alpha. Data for the time period 1/1/1951 – 12/31/2019.

Pick any measurement of your liking and this present set of circumstances is near the top of every measuring yardstick. Price-to-earnings (P/E), price-to sales (P/S) and price-to-book value (P/B) are all at 94-year extremes.

Massive negative psychology among individual and professional investors

Source: Barron’s & Bespoke Investment Group. Data as of 3/5/2009.

Think how crazy bearish investors were in 2009 near the bottom. Eighty-nine percent of them thought the market would go down and 61% of them thought it would go down a great deal at the bottom.

Source: Cypress Capital Sept 9, 2020. Data for the time period 1/1/1987 – 9/30/2020.

Today, untested initial public offerings (IPOs) and special purpose acquisition companies (SPACs) are sprouting up everywhere and being bid through the roof. Investors ignore very real antitrust threats to the biggest and most glamorous tech companies. It is like it is getting closer to midnight and these Cinderella investors don’t have a clock or watch to know when the time strikes midnight. Then everything caught in the frenzy will turn to “pumpkins and mice.”

Normally successful and admired money managers called out on the carpet and in some ways humiliated (preferably on the front page of The Wall Street Journal)

Source: Bloomberg. Data for the time period 1/1/2019 – 10/31/2020.

The ridicule in December 2020 is reserved for respected managers who both go long and short in stocks. They have been clobbered by short positions gone wild. Back in 1999, we remember one of the clients of the firm I worked at was short eBay and got destroyed!

Source: Bloomberg. Data for the time period 2/27/2015 – 11/30/2020.

Anyone shorting over-valued securities has been crushed in the last two years.

Source: Thomson Reuters. Data for the time period 11/1/2019 – 11/30/2020.

While the short sellers get crushed, the insiders at these firms are dumping shares like there is no tomorrow.

Buy and hold investing viewed as an idea that is no longer useful

Source: Cypress Capital October 2, 2020. Data for the time period 1/1/2000 – 9/30/2020.

Here is Jim Cramer’s explanation of the current frenzied appreciation for glam tech stocks:

Jim said that, “Tesla is the stock that broke how we view stocks. It’s a totally unconventional way to look at stocks, and younger people look at a company that can make a battery and they dream dreams. They don’t go with the spreadsheet. They see things that we don’t see.” But, dreams don’t survive very long without spreadsheets.

Seemingly unsolvable economic problems as part of a deep recession

“The 40 years ending in 1941 included the stock market panic of 1907, which drove down the Dow Jones Industrial Average nearly 38 percent; the World War I Era, where the period between 1910 and 1919 was one of the worst ever for stocks; AND, oh yes, the Great Depression. Finally, icing on the 40-year cake, the Japanese bombed Pearl Harbor on December 7, 1941.” (O’Shaughnessy Asset Management)

Source: Cypress Capital. Data for the time period 1/1/1970 – 12/31/2019.

The nice thing about economics is its lack of biases. We think that the Federal Government throwing borrowed money at the economy and the Federal Reserve Board printing money will solve our economic problems. History would say it could cause an inflationary boom and a mad dash for inflation beneficiary stocks like real estate, housing and oil.

Accommodative Federal Reserve Monetary Policies and stimulative fiscal policies from the U.S. Government

Source: frbatlanta.org. Data for the time period 12/1/2007 – 12/31/2008.

The picture paints 1,000 words. In 2009, the table was set for tasty stew.

Source: Cypress Capital. Data for the time period 1/1/1965 – 6/30/2020.

Today the table is set for major bond market misery.

Public short selling had hit record levels

Source: Value Line. Data as of 12/26/2008.

Source: Cypress Capital Sept 9, 2020. Data for the time period 1/1/2000 – 6/30/2020.

Public call buying and small Robinhood investors have gone gaga over stocks.

Cash in Money Market Funds at record levels in relation to stock market capitalization and paying low interest rates

Source: Hays Advisory. Data for the time perios 1/1/1990 – 12/31/2009 (left); 1/1/1974 – 12/31/2010 (right).

Source: Cypress Capital. Data for the time period 1/1/1974 – 9/31/2020.

Very intelligent and credible economists and analysts explaining clearly and logically how terrible things are going to be for many years

Source: Bespoke. Data for the time period 1/1/1990 – 6/30/2020 (right).

When the leaders of the most successful tech companies dress up like homeless people to go on television, you get the sense that their arrogance is reaching the outer limits. We believe the capital destruction following this “frenzy” could be legendary and rank with the dismantling of the “Nifty Fifty” stocks of 1972 and the tech bubble stocks of 1999.

What does it look like before growth bubbles break?

Source: Cypress Capital Sept 9, 2020. Data fore the time period 1/1/1960 – 6/30/2020.

The four most expensive words in the English language are “this time it’s different.”
—Sir John Templeton

The opportunities for investors in 2021 could be found in the economy outperforming the stock market, with investors pursuing inflation beneficiaries and companies which are semi-protected from inflation. They could find it in the necessities demanded by 90 million millennials having kids, needing houses, cars and everything that goes with them.

We expect the seeds we planted during the terrible storm in the stock market in 2020 to pay off handsomely if inflation rears its ugly head. It could be one of the few ways to prevent stock market failure. We thank you for your ongoing confidence in our stock picking discipline and believe that the rewards available from avoiding the crowd and surviving the storm could be substantial.

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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