Mama said there'll be days like this
by William Smead, Smead Capital
We are nearly five months into 2016 and will call on the great singing group, The Shirelles, to explain what has been going on in the U.S. stock market:
“Mama said there’ll be days like this
There’ll be days like this, my mama said
I went walkin’ the other day, yeah
Everything was goin’ fine
And then I met a little boy named Billy-Joe
And then I almost lost my mind”
This market is bedazzled by revenue growth stories in an economy that has lacked pizazz. It isn’t “Billy Joe” who has market participants “losing their minds,” it is Jeff Bezos, Mark Zuckerberg, Reed Hastings and Elon Musk. While we seek out already profitable companies that fit our eight criteria for stock selection, most market participants are looking for companies with maximum business momentum. They are drawn to corporate players in the latest edition of what we are calling “tech arrogance.” To us, tech arrogance is the idea that technology is an end in itself and that nothing can stand in its way.
“My eyes were wide open
All that I could see, yeah
The chapel bells were tollin’
For everybody but me
But I don’t worry ’cause
Mama said there’ll be days like this
There’ll be days like this, my mama said”
Our “eyes” are “wide open” to what is working in the current environment. There has been a sizable bounce in energy, utilities and consumer staples stocks. To us, this shows that investors clearly think the rebound in oil prices circa 2009-2010 from $32 to over $100 per barrel is being repeated. They want to hear “chapel bells” if oil rebounds to $60 and holds there. They want the current boom-bust cycle to be over much sooner than the historical 7-10 year time frames.
When it comes to buying stocks for dividend yield only, we refer to Ray Devoe who said, “More money has been lost chasing yield than at the point of a gun.” The easy way to understand this is to watch what the “smart beta” ETF firms are advertising on the financial news programs. The hot categories are yield and low beta. These same firms were hot for Japan and small-cap Europe one year ago. However, expensive staple stocks are “For everybody but me.” We’d much rather own a wonderful company in biotech/pharma at 14 times First Call 2016 estimates like Amgen (AMGN) with a 2.6% dividend than pay 22 times estimates to get a 3% dividend from a staple stock.
Let’s stop the music at this point in the discussion to remind folks of a few facts we believe. First, every long duration common stock picking organization has to choose their “days like this.” We choose to underperform futuristic momentum markets and are not interested in capital-intensive and labor-intensive businesses which require us to be right on macro-economic predictions. Second, we like the compounding affect from long holding periods. Pretty much all stocks that outperform over ten years have at least two patches of poor stock price performance. Third, Warren Buffett says that “excitement and expense” are the enemy of our common stock portfolios. The only way to avoid the cold stretches in the stock market is to practice higher turnover and to hold a great deal of cash. We are not willing to spend our investors’ money on trading costs or volunteer them to pay the capital gains taxes that go with it. Lastly, we don’t believe anyone does well with market timing.
What do we think “Mama” would say to us if she could give advice on how to be best positioned for the future? We think she’d tell us to bet on strong companies being neglected by tech arrogance. She might suggest old media stocks like Tegna (TGNA) and Gannett (GCI), which have been shunned in this environment. Investors were pumped up about them when activists were on their trail, but now let them trade at very attractive price-to-earnings (PE) multiples. They gush free-cash-flow and are very preoccupied with improving the toll bridge nature of their media businesses.
She also might have proposed some emphasis on a stronger U.S. economy, led by housing. It is our observation that the financial experts are ill-prepared for making money in stocks most benefitted by a housing boom. After all, the index should do well if computer science majors are also doing well, but the index represents very few carpenters and plumbers. The stronger economy could be caused by pent up demand from millions of 28-35 year old Americans, who should be tired of being abused by expensive rent. We like NVR (NVR), the builder of Ryan Homes, from Florida to Pennsylvania.
Mama would warn us that the current market infatuations and narrow nature could go on for quite a while. The worst euphoric episode, the tech bubble of the 1990’s, lasted more than three years after Alan Greenspan warned of “Irrational Exuberance” in 1996. In 2015, FANG stocks (Facebook, Amazon, Netflix and Google) dominated the U.S. large-cap benchmark S&P 500 Index. This particular episode is about 18 months old so far. In 2016, it is even narrower. Only the FA stocks are rising smartly and making the index look relatively good. Millennials like Pho’ (a trending Vietnamese food) and investors like Facebook/Amazon, so this all makes sense! The “chapel bells are tollin'” in investments outside our discipline and “Billy Joe” isn’t the guy for us!
Lastly, Mama would remind us to find contentious, quality companies and hold them for a long time, because “there will be days like this.” She would also remind investors that glamour, high-PE stocks break badly when the momentum dies. As any good Mama would do, she’d tell us “don’t worry” and stick to our three core tenets– valuation matters dearly, hold businesses for a long time and stick to high-quality companies.
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 and CEO, 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.
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