Buffett and Munger Mark the End of An Era

by William Smead, Smead Capital Management

Dear fellow investors,

At the Berkshire Hathaway Annual Meeting we marked what we believe is the end of an era both for Berkshire and for the S&P 500 Index. In Berkshire’s case it is the loss of Charlie Munger and the passing of the baton from Warren Buffett to his well-prepared team. In the case of the index it is the rhymes surrounding the past major peaks in stock market euphoria and what Munger and Buffett have said publicly.

Buffett said at the Berkshire Hathaway Annual Meeting over the weekend that Artificial Intelligence (AI) can produce a great deal of good and a great deal of evil in the form of scamming. The video of Charlie saying that a euphoria episode is “like a chain letter or a Ponzi scheme and when it gets combined with a legitimate development, like the internet, it is like combining raisins and turds. You still end up with turds!” We believe that AI is a legitimate development, but it is coming at the late stages of the fourth euphoria episode of the last 100 years (1929, 1969, 1999 and 2021).

At Smead Capital Management, we believe investors are going to be extremely negatively impacted by the hangover from the euphoric emergence of AI. The reason lies in the historical behavior of the stock market in relation to major life-changing technology. History shows that the stock market benefits of technological advances come 10 years after the original excitement.

Radio changed everyone’s life between 1923 and 1941. One percent of U.S. households had a radio in 1923, and by 1937, that number grew to 75% household penetration. In 1941, the most famous radio address was conducted by President Franklin D. Roosevelt. He said, “December 7, 1941, is a day that will live in infamy!” The U.S. declared War against the Axis powers.

RCA was the largest maker of radios, one of two large national radio broadcasters and one of two large radio content producers. As is the case for new technologies in the investing world, RCA saw a blistering gain between 1925 and 1929 in what is referred to as the Roaring 1920s:

However, from October 1929 to May 1941, you would’ve lost over 80% of your investment in RCA. Eventually, from 1941 to 1968, RCA was spectacular!

Many new technologies were spurred forward by the space race from 1955 to 1969. Television’s popularity exploded and business use of computers (IBM) contributed to a euphoric stock market era called the Go-Go 1960s. T. Rowe Price and Warren Buffett pivoted away from stocks by shifting to inflation hedges like oil, commodities and gold (Price) and giving his partners cash back in 1969 (Buffett). Buffett said in early 1969 that “investors had moved from lethargy ten years before to acute hypertension at the end of 1968.” This era ended on the two-year bull market led by 24 stocks in the two Nifty-Fifty lists at Morgan Guaranty and Kidder Peabody. Stocks didn’t get attractive at the S&P 500 Index level until 1982. Here is how the market treated shares of Disney (DIS) and Coke (KO) from the end of 1972 to the end of 1982:

Jump ahead to the late 1990s euphoria related to the introduction of the internet and the mania tied to it which did change our lives. Tech stocks soared in 1998-1999, just like Nvidia (NVDA) has in the last two years. This was despite a severe Fed tightening cycle by then Fed Chairman Alan Greenspan who could see that a financial euphoria episode had developed. He called it “irrational exuberance” in 1997! Like Charlie Munger just called it “turds!” Here is how Amazon (AMZN) and Cisco (CSCO) traded from January 1, 2000 to December 31, 2002, as two of the most popular ways to participate in the legitimate development called the internet:

This time, the stock market believes the AI phenomena will change our lives as it elongates the financial euphoria episode that Munger called, in November of 2021, “the biggest euphoria episode of his career!” Again, Munger had been through the Go-Go 1960s and the DotCom bubble. We are advising extreme caution for investors who fear stock market failure. This chart of low dividend stocks relative to high dividend stocks does a good job of showing where we are compared to 1969 and late 1999:

Here is why we are extremely cautious: Like the prior euphoria episodes, the AI craze has hit the stock market like wildfire. Investors feel like it is a train they must catch, even if it gets severely interrupted at some point. It is, as Munger says, “a legitimate business development.” However, it is coming toward the end of a massive euphoria episode in stocks that is strong enough to withstand a 500-basis point Federal Reserve tightening and a tech bear market in 2022. Therefore, the raisins of AI are intertwined with the financial euphoria turds!

As responsible fiduciaries and stock pickers, we must defend our capital until this euphoria gets purged through severe losses in the S&P 500 Index, which is “all twisted up” in the euphoria of this era. Join us in patiently waiting through the last phases of the euphoria and the bargains that we believe could be available to us as a result. Lastly, recognize that we are close to the end of an era.

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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