Forget 2008 While Avoiding Popularity

by William Smead, Smead Capital Management

We continue to be encouraged by the endless interest in doomsday writing about the next 2008 and the way asset allocators have positioned themselves to defend against its possibility. The most popular writers seem convinced dismal returns are in front of us, economic success in the US is impossible and that the next US stock market decline will punish fully-invested common stock owners. It is our belief the next ten years will include two bear markets of over 20%. Recent reports of significantly lower US large-cap ownership of common stocks among major institutions and high-net-worth individuals compared to historical norms make us confident as a firm that long-duration common stock owners should be much more concerned about what they own, rather than whether to own.

In a relatively optimistic stock market environment like this one, you can look for anecdotal evidence to avoid the kind of popularity that can damage long-run returns in normalized declines. Investor’s Business Daily’s writer Ciaran McEvoy was very helpful on June 27th, 2014. He wrote a piece called, “Public’s Faith In Banks Still Near Record Lows.” Here is how he explained the recent Gallup Poll data:

Banks aren’t going to win any national popularity contests anytime soon, as a measly 26% of Americans expressed a “great deal” of confidence in them, according to a Gallup poll.

That number is unchanged from last year and is 15 percentage points below the pre-recession number in June 2007, but it is an improvement over the record low of 21% found in 2012. When Gallup began measuring public confidence in banks in 1979, 60% of respondents expressed a great deal of confidence in the sector — a number it has yet to match.

We keep harping about how hard it is to get a major decline out of a sector which has a low level of popularity, garners regular political, legal and regulatory attacks and is getting smeared in the media. We like to call Bank of America (BAC) and JP Morgan (JPM) the new Philip Morris. They trade at low prices in relation to book value and should see huge earnings growth as professional barn-door closers like Eric Holder and Elizabeth Warren run out of animals which are already gone. Phillip Morris has been a spectacular stock for the last 50 years and it had very low levels of popularity, was attacked politically, legally and by regulators.

From our perspective, most investors assume that the major banks will be poor performers in the next stock market decline. The companies own large wealth management businesses and are mistakenly considered winners in a declining interest rate environment, in our opinion. Some research we’ve seen indicates that money-center banks had significantly stronger earnings growth in rising interest rate decades than they did when rates went down. Money market funds could see massive increased profitability when short-term interest rates are allowed to normalize as the economy improves over the next three years—toss in an immense surge of auto and mortgage loans coming forth in the next five to ten years from emerging echo-boomers, and we foresee some very happy earnings reports.

There are more clues about business and stock market popularity in the latter half of Mr. McEvoy’s article.

But it’s not all bad news for banks. They tied with public schools and still outranked the news media, the health care system, organized labor and big business in terms of public confidence. Congress came in dead last with a mere 7% of respondents expressing “quite a lot” of confidence in its 535 members collectively.

This makes us very pleased to own an over-weighted position in healthcare companies like Pfizer (PFE) and Amgen (AMGN). We own a major position in the news media industry via Disney (ABC), Comcast (NBC and cable news distribution) and Gannett (46 network-affiliate TV stations and 82 daily newspapers). We hope to outperform the next major stock market correction in these unpopular industries. We think it is too bad that there is no quality stock fitting our eight criteria which would be a play on a rebound in the popularity of Congress. Frank Underwood, the Congressman in House of Cards, is probably marking the bottom in confidence in the institution.

Warm Regards,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

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