Noah’s Stock Market

by William Smead, CIO, Smead Capital Management

Dear fellow investors,

There is a popular song on my favorite radio station called, “Build A Boat.” It is, of course, a reference to Noah’s Ark. Since Steve Carell played the part of Noah in Evan Almighty most everyone is familiar with it. It hadn’t rained for a long time, and Noah was inspired to build a massive boat in the desert. Everyone thought he was crazy; we who live in Phoenix haven’t seen any rain for months.

This is truly a Noah stock market. Everything we have studied about common stocks, including The Intelligent Investor by Ben Graham, A Short History of Financial Euphoria by John Kenneth Galbraith, and from listening to the wise words of Charlie Munger and Warren Buffett for decades leads us to believe that we must build a common stock portfolio which will float when the multi-year bear market creates a waterfall of selling among magnificent growth stocks and passive S&P 500 Index owners.

Think about the wise phrases these great men have uttered.

• “The intelligent investor is one who sells to Optimists and buys from Pessimists.” -Ben Graham

• Excerpt from “A Short History of Financial Euphoria” by John Kenneth Galbraith:“There is the possibility, even the likelihood, of self-approving and extravagantly error-prone behavior on the part of those closely associated with money.

  A further rule is that when a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of unique opportunity based on special foresight, all sensible people should circle the wagons: it is the time for caution.”

• “This is the biggest euphoria episode of my career because of the totality of it.” - Charlie Munger
• In May of 1999 Munger said, “A financial euphoria episode is like a chain letter or a Ponzi scheme and if you add a legitimate development to it, it’s like mixing raisins with turds and you end up with turds.”
• “Be fearful when others are greedy and greedy when others are fearful.” -Buffett

Why are normally wise people caught up in this euphoria episode? First, it is the most all-encompassing momentum market of my 45 years in the investing business:

Second, the interruptions of the momentum haven’t lasted very long. Think of it like Buffett does. He says, “When the tide goes out, you find out who is swimming naked!” The corrections haven’t taken the S&P 500 Index much below the S&P 500’s belly button. Or Buffett compares it to being Cinderella at the ball. She knows that when the clock strikes 12 pm it is all going to turn into pumpkins and mice. However, just like in the fable, there is no clock on the wall, and this all-time great momentum growth stock market has no clock on it.

Third, a great deal of this momentum market is attached to Baby Boomers like me. We started in 1980 with very high interest rates (15%) and very cheap stocks at 7.5 times earnings.

Now, we are the largest and most affluent set of 60-80-year-old Americans in history. We own a ridiculously large percentage of the U.S. stock market, and like Pavlov’s dog, we wait for the stock market to open each day so we can get fed by the incredible 15-year run in the passive market cap weighted S&P 500 Index.

What are we doing? We are assuming that inflation won’t back down. Ask the dock workers or Boeing machinists what a long-term union contract that raises your income 8.5% per year compounded means. Ask the U.S. Postal Service why they are raising last-mile delivery prices by 60% and forcing UPS to cut Amazon deliveries in half! Ask employers of unskilled labor what they must pay workers to feed restaurant food to flush and happy boomers like me.

Significant scarcity of commodities like oil and gas will develop as Permian Basin fracking sees declining production and explosive price increases. Remember, AI is Munger’s legitimate development and natural gas is the key to electricity production in the U.S.

People on both sides of the aisle seem to find President Trump and Fed Chairman Powell’s out-front openness in dealing with some of our country’s problems refreshing. However, we watched Paul Volker and President Reagan do just about everything right in defeating double-digit inflation in the early 1980s, and that is why U.S. baby boomers have become wealthy as a group in the stock market. These fat union contracts don’t look like the beginning of a long stretch of 2% inflation and that is possibly what will ruin the S&P 500 gravy train.

In conclusion, we wake up each day and attempt to build and own a stock portfolio that will float without the help of momentum. When will the rain start to fall? Noah didn’t know; he just did what he was told by someone who knew better than him! We will listen to the wise men we quoted above!

Fear stock market failure,

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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