A Ticket to Purgatory

by William Smead, Smead Capital Management

Dear fellow investors,

The Sherman Antitrust Act was created to stop our democratic republic from being ruined by “the concentration of capital in vast combinations.” The fear was that if too much of the success of industry went to too few people, our system would get disrupted.

The bad news is that the federal government has ignored the original purpose of the act. In our opinion, our society was first disrupted by the success of the FANG stocks and is now being disrupted by the Magnificent Seven. The good news is that the stock market has a history of solving problems on its own. What has happened over time to the largest and most popular stocks as measured by market capitalization?

The chart above shows the relative performance if you bought the ten largest cap stocks in the S&P 500 Index at the start of each year and separately purchased the next 490 stocks in the index. You would have had occasional victories in the top ten, like in the recent 10 years, but massive long-term heartache over the last 65 years (thank you to GMO, Compustat and Standard & Poor’s).

What are the arguments in favor of sticking with the Magnificent Seven and the S&P 500 Index masquerading as a diversified portfolio? First, it is different this time! However, it is always different this time and it is the rhyme with prior manias and top ten lists that sends you to purgatory. How did the Go-Go 1960s and Nifty 50 stocks work over ten years? How have Cisco and Intel done since 2000?

Second, the ticket into purgatory doesn’t always have to come in the U.S. Look how bad the top ten list from 1990 did with eight of ten coming out of Japan or the 2010 list dominated by the China-led BRIC trade. Mania is an equal opportunity destroyer of wealth!

Lastly, many people look at this mania and compare it to the dot-com bubble of 2000. This comparison is like a fraternity brother feeling comfortable drinking 14 beers because his best friend knocked out a whole case. Nobody wrote either of them a letter and said, “You are too well to attend.” As Cole shared with us last week, the difference from the Dotcom Bubble included 1% interest rates for a very extended time period. Therefore, many more of the 500 companies in the index have been inflated by nearly free money. Buffett says, “The kinds of companies we would like to own have been endlessly picked over!” This means the bear market that follows will include company shares outside of tech. The capital that doesn’t get destroyed will flow into a smaller pool of depressed stocks.

In summary, we have no urge to go through purgatory with popular stocks that lead to long-term heartache. This mania appears to be headed to a bad ending. As always, fear stock market failure.

Warm Regards,

William Smead

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, 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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