4Q22 U.S. Value Strategy Newsletter: Shame on Me in 2023

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The old adage says, “Fool me once, shame on you. Fool me twice, shame on me!” We at Smead Capital Management believe the stock market wants to cause stock market failure by being extremely difficult in 2023. Most investors were fooled in 2022 by expecting circumstances similar to the prior ten years. Now, most investors have leaned into the idea that the 18.17% decline in the S&P 500 for the year 2022 is a one-and-done.

One of the keys to successful investing is being rational. Here are a series of reasons to expect difficult 2023 waters in the S&P 500 Index:

  1. Charlie Munger called the financial euphoria episode which ended in late 2021 the biggest one of his career, because of “the totality of it!” We have analyzed the unwinding of prior major euphoria episodes in 1929, 1972, 2000 and 2007. The abuse to maniacal bull market darlings lasted two to three years and took an even bigger toll on the index than the 2022 year did.
  2. Watching QQQ commercials on television and seeing growth stock portfolio managers and analysts lean into buying dips in the former glam tech stocks matches up with the prior episodes. Polaroid got pummeled for three years in 1929-1932. Disney and Coca-Cola were torn apart in 1973 and 1974. Microsoft, Cisco and Intel got crushed by the entirety of the 2000-2003 bear market and were dead money for ten to twenty years.
  3. Stocks are not cheap as a group. The current stock market is expensive on a price-to-earnings ratio basis compared to previous bear market low points. The difference in 2003 was interest rates were headed down and not up like they are now. Second, most of the 2000-2003 bear market abuse was in technology, telecom and dotcom stocks. There were multiple industry groups that made money during the 2000-2003 bear market and very few in 2022.
  4. Interest rates haven’t fully normalized. It is hard to visualize the stock market starting a new bull market until the Federal Reserve Board finishes tightening credit to address what they use to think was “transitory” inflation.
  5. Sentiment is bearish and favorable under normal conditions. However, the analysts who cover FAANG and other glam tech stocks have not given up. At the bottom of the 2007-2009 bear market, 80% of those polled thought the Dow Jones Industrial Average would go dramatically lower when asked in March of 2009 near the bottom at 6500.
  6. Commodities look very attractive relative to stocks and that doesn’t bode well for equity performance.


    Source: FundStrat.

Our Goals for 2023

  1. Avoid stock market failure by being preoccupied with defending our capital. We will look for an even larger “margin of safety” than normal. We will get that by using lower-than-consensus earnings estimates and calculating net present value using much higher than current ten-year Corporate Bond rates.
  2. Bet that the largest population group (millennials) will use most of their income on necessities and reduce the kind of discretionary spending they did as single apartment dwellers from 2010-2020. We see homes that need to be built, cars made, children born and all the spending attached. We also see them spreading out across the country to arbitrage land values.
    Source: FundStrat.
  3. We will invest in scarcities. Fossil fuels will be needed for decades, not years. We will join President Biden in buying all the oil in the ground we can find. We will build homes nationwide and own land with premier shopping, restaurant and entertainment facilities. If it looks to you like we believe in ongoing inflation problems, you guessed correctly.
  4. As we always do, we will invest based on superior long-duration performance. This means ignoring short-run difficulty to get at the future income streams over the next ten years. We must act and think like owners of these businesses because we are partial owners of them.

In summary, we are looking for bright futures among companies that meet our eight criteria for stock selection which are aligned with maximizing returns from necessity spending in an inflationary environment. Thank you for your confidence and trust in our portfolio management discipline.

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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