There are three pillars of investing for us at Smead Capital Management. First, we must know the history of the stock market. Second, we must understand the mathematics of the stock market. Third, we must understand the psychology of the stock market. As we enter the year 2022, we believe the S&P 500 Index and the oil/gas Industry are at polar extremes on all three pillars.
The table below reports the latest values of the eight indicators reported each month by Mark Hulbert from Marketwatch.com. These are the eight ways of measuring ten-year forward return which have been statistically meaningful, according to his research. These regression modules have the best long-term records predicting the stock market’s 10-year returns. As you can see, it’s not just the average household’s equity allocation that is bearish about the stock market’s longer-term prospects.
Source: Mark Hulbert – MarketWatch
Out of eight shots which demonstrate future 10-year returns, only a wild-eyed optimist below 40 years of age with a Robinhood trading account and a savings account loaded with “stimmy” checks would want to fight this statistical battle.
As you can see above, even if the regression analysis was in your favor, like in 1980, 1990 and 2010, owning the ten-largest-cap companies in the S&P 500 Index was a ticket to underperformance, and in many cases, stock market failure.
Prior Euphoria Episodes with difficult 10-year Regression Numbers
Here are the index results from prior financial euphoria episodes with regression numbers similar to today:
Source: Bloomberg. Data from 12/31/1928 – 12/31/1938.
The Nifty-Fifty Stocks of 1972
Source: Bloomberg. Data from 12/31/1968 – 12/31/1978.
The DotCom Bubble of 1999
Source: Bloomberg. Data from 12/31/1999 – 12/31/2009.
While the Index appears to be at an extreme on all three of these pillars, how does this guide us as value investors? Can you make money in an elongated stretch of poor index performance? How can you be optimistic about energy when the crowd is bending over backwards to invest in every ESG initiative known to man and portfolio managers are embarrassed or ridiculed into avoiding the energy sector? To answer these questions, let’s go to the evidence.
History of ESG Investing
Nixon Signs Bill Banning Radio‐TV Cigarette Ads: April 2, 1970
The way we view it, this was the beginning of ESG investing. The government intervened in the free market and mandated that it was not good for our society to advertise cigarettes on radio and television. This led to consistent divestment of tobacco stocks by portfolio managers over the following decades.
Phillip Morris: The best performing stock in the entire NYSE
As you can see below, Phillip Morris (MO) was the single company which was to be the most negatively impacted by the government intervening in the cigarette industry. Ironically, it was the best performing stock of the next forty years and this chart shows its run from 1980 to 2017.
Mathematics of ESG Investing
Here is a list of the largest cap stocks in the iShares Global Clean Energy ETF which appear to give investors participation in the seeming ESG gold mine:
When you sit down to play poker, if you can’t figure out who the sucker is at the table, you are the sucker! Why does anyone believe that they can figure out who will win this game?
Lastly, the psychology of the moment looks to us like the cartoon below:
We are willing to bet a big part of our ranch that the ESG motive is like buying an effort to find needles in the haystack. Yes, someone will probably be successful out of the hundreds of money-losing companies trying to satisfy morally-arrogant investors. However, the totality of what they will accomplish will look like Geo Cities, Lucent and Sun Microsystems did in 2000-2010, in retrospect. Here is how Warren Buffett describes the logic of the moment:
“The key to investing is not assessing how much an industry is going to impact society, or how much it could grow, but rather, determining the competitive advantage of any given company and, above all, the durability of that advantage.”
It is enough to make us want to put all this in the Metaverse; which is an extremely heavy energy consumption electronic activity.
The best way to understand where we are going is to look at the evolution of the most popular TV shows. In 1962, the “Beverly Hillbillies” debuted and was an instant comedy hit. It was the story of some folks from the country who discovered oil on their property, struck it rich and moved to Los Angeles. The show topped the charts and spawned a series of comedy shows like “Petticoat Junction” and “Gilligan’s Island.”
Jed Clampett, Source: Forbes.
In 1981, the most popular broadcast television show of all time, “Dallas,” was the story of a ruthless and mega-wealthy family (the Ewing family). The eldest son ran the business and was sleeping with women all over town. J.R. Ewing, played by the former astronaut in “I Dream of Jeannie” (Larry Hagman), was shot by someone and everyone had to tune in to find out who shot him. We believe it was the largest market share episode of TV prior to the advent of streaming.
JR Ewing, Source: TNT.
You see, Americans were enamored and envious of oil people, because the oil business was the best way to get rich in the 1970s. See the oil price chart below:
WTI crude oil price per barrel from 1970 – 1980:
Where are we now? There are no popular oil business TV shows and nobody wants to invest in the future of the business. Even most people who run oil and gas companies don’t want to invest in future production or they are being brow-beaten into low levels of capital spending, while trying to please the ESG mafia.
Therefore, a massive amount of relatively inexpensive oil and gas is needed for auto transportation and to produce electricity for electric cars. Like Warren Buffett says, “The people who think we will make a quick transition away from carbon transportation and the people who think we will never transition away from carbon, are both crazy!”
The moral of the story for us is that we need to invest heavily in the attractive and unloved polar extreme of the oil and gas business. Second, we need to believe the overwhelming evidence that ten-year returns in an index, which is overloaded with what you should have bought ten years ago, is dismal. The companies which investors are most enamored with are Apple, Microsoft, Amazon, Alphabet, Facebook and Tesla. This reminds us of when the oil people had the most popular TV show. Remember this while you watch “Spiderman,” “Billions,” “Succession,” and “Silicon Valley.”
Thank you for investing with us and coming along for the ride. And, as always, 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.
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