Same as it Ever Was

by William Smead, CFA, Smead Capital Management

Dear fellow investors,

We’ve always admired the great artistry of David Byrne from the Band Talking Heads. My favorite song of theirs is “Once in a Lifetime.” We think this song can tell our readers a great deal about how to look at our portfolio as we navigate an expensive and maniacal S&P 500 Index environment.

And you may find yourself living in a shotgun shack
And you may find yourself in another part of the world
And you may find yourself behind the wheel of a large automobile
And you may find yourself in a beautiful house, with a beautiful wife
And you may ask yourself, “Well, how did I get here?”

How we got here is that interest rates went down from 1981 at 15% long-term Treasury Bond rates to 1% in the COVID-19 environment of 2021. Also, stocks have gone up off and on for those same 40 years. We think it puts index investors in a “shotgun shack,” waiting to get shot down when this euphoria era ends. Here is a picture of why “you may need to find yourself in another part of the world!”

Source: Bank of America Research.

Stocks outside the United States are historically cheap for a variety of reasons. However, the number one reason is the great run that the FANG stocks and the successor Magnificent Seven stocks have had. They have caused the S&P 500 Index to be the most concentrated and tech-heavy in U.S. history. Today, the tech sector, along with Alphabet, Facebook in communication services and Amazon, Netflix and Tesla in consumer discretionary, are close to 47% of the 500-stock index.

Letting the days go by, let the water hold me down
Letting the days go by, water flowing underground
Into the blue again, after the money’s gone
Once in a lifetime, water flowing underground

We think S&P 500 Index investors are heading “into the blue again” and we might not find them until “after the money’s gone.” A stock-picking discipline like ours could shine on a relative basis. We recently reread John Kenneth Galbraith’s book, A Short History of Financial Euphoria. He reminds us that euphoric episodes are a normal and an important part of investment markets. However, the commonalities of easy money, massive debt and manic excitement about stocks or gold or crypto or art or tulips always ends the same. With stocks, it looks like this:

1929 – 1942

1972-1982

1999-2009

Source: Bloomberg.

And you may ask yourself, “How do I work this?”
And you may ask yourself, “Where is that large automobile?”
And you may tell yourself, “This is not my beautiful house”
And you may tell yourself, “This is not my beautiful wife”

Our large-cap value strategy is not the “same as it ever was,” but it looks very attractive relative to the stock-picking disciplines we compete against. We own a portfolio that is cheaper on traditional value metrics in price than the S&P 500 Index (as cheap relatively as almost any point since inception) and most value portfolios. And we show relatively stronger balance sheets and return on equity than most of our competitors. This shows “How do we work this?” We really are very similar by metrics to where we’ve always been. We feel like we have a “large automobile,” a “beautiful house,” and a “beautiful wife.”

We’ve talked recently about some of our most out-of-favor stocks like Merck (MRK), Target (TGT) and the oil and gas stocks like Cenovus Energy (CVE), APA Corp. (APA), Devon Energy (DVN) and Ovintiv (OVV). A recent report showed that hedge funds are the most bearish on oil and gas stocks since 2020. They want fast action, and we like impatient competition. All along the way we have some things going very well (think home builders and banks) and numerous deeply out-of-favor bargains that are yet to be recognized in the stock market.

Ironically, one of our strengths is benefitting from long holding periods as we are “letting the days go by.” Investors requiring maniacal glam tech stocks and overpriced quality growth stocks to succeed could wonder what hit them “after the money’s gone!”

Same as it ever was, same as it ever was

While we stand against this euphoria episode, please be comforted by the fact that we are being “fearful where others are greedy and greedy where others are fearful!” We’d like to think it is the key to fearing 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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