Episode #290: Bill Smead, Smead Capital Management, “There’s Less Respect For Stock Picking Experts Right At This Moment Than There Has Been Since The Peak Of The Dot-Com Bubble”
Guest: Bill Smead is the Chief Investment Officer for Smead Capital Management. He is the final decision-maker for investment and portfolio decisions and is responsible for reviewing the implementation of those decisions in the firm’s separate accounts and mutual funds. Prior to founding Smead Capital Management in 2007, Bill was the Managing Director/Portfolio Manager of Smead Investment Group of Wachovia Securities. Previously, he was with Smith Barney and Oppenheimer & Co. Bill began his career in the investment business with Drexel Burnham Lambert in 1980.
Date Recorded: 2/3/2021
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Summary: In episode 290, we welcome our guest, Bill Smead, the Chief Investment Officer for Smead Capital Management.
In today’s episode, Bill explains why he believes the market is undergoing a tide change. He starts with a look back on the 2000 tech bubble and uses Cisco as an example of why it’s important to separate a good business from a good stock. After talking about parts of the market he doesn’t like, we move on to the parts he finds attractive, including home-builders, energy, suburban mall REITs, and financials.
As we wind down, Bill touches on the antitrust case for big tech and what the investment implications may be.
Please enjoy this episode with Smead Capital Management’s Bill Smead.
Links from the Episode:
- 0:39 – Intro
- 1:25 – Welcome to our guest, Bill Smead
- 2:16 – Why we’re talking about clamming
- 4:19 – Tide transitions at the end of the dot-com bubble
- 6:15 – Long-term results for the top dot-com stocks
- 7:25 – Current expectations for glamor stocks
- 8:51 – Why it is important to remember that tech is cyclical
- 9:36 – Tesla and GameStop: Pass the Dutchie? (Smead)
- 11:08 – Wisdom of the crowds and the lack of fundamentals
- 13:35 – WFH is a WKF (Smead)
- 15:14 – The future of energy
- 17:08 – The impending boom in the housing market
- 18:57 – The Meb Faber Show Episode #150: Bill Smead, Smead Capital Management, “The United States Economy Is Highly Likely To Be The Strongest The Next 10 Years It’s Been Since The Baby Boomers Went Through The 30 to 45-Year-Old Age Range”
- 20:46 – Recognizing parallels between current and past economic events
- 22:29 – Keeping pace with the S&P 500 during a difficult period
- 24:15 – The challenge with long-term investing horizons
- 27:33 – Massive problems caused by anti-competitive behemoths
- 29:50 – The multiplier effect of a booming industry
- 31:06 – Breaking Rockefeller: The Incredible Story of the Ambitious Rivals Who Toppled an Oil Empire (Doran)
- 31:47 – Americana: A 400-Year History of American Capitalism (Srinivasan)
- 32:21 – Bill’s prediction of Occupy Monopolies
- 34:10 – The Great Crash 1929 (Galbraith)
- 36:30 – Investing with post-COVID behavior in mind
- 39:08 – Waiting for P/E ratios to contract
- 41:49 – Why young people have a tough entry point to investing
- 44:21 – The shift from discretionary to necessity spending
- 45:46 – Bill’s thoughts on the companies to watch
- 48:54 – Learn more about Bill and Smead Capital Management
Transcript of Episode 290:
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Howdy, friends? We got another great show for you today. Our guest is the chief investment officer for Smead Capital Management, one of our favorite guests from all of 2019. And today’s episode, we invite our guest back to explain why he believes the market is undergoing a tide change. He starts to look back on the 2000 tech bubble and uses Cisco as an example of why it’s important to separate a good business from a good stock. After talking about the parts of the market he doesn’t like, we move on to the parts he finds attractive including homebuilders, energy, suburban mall REITs, and financials. As we wind down, our guest touches on the antitrust case for big tech and what the investment implications may be. Please enjoy this episode with Smead Capital management’s Bill Smead. Bill, welcome to the show.
Bill: Thanks for having us.
Meb: You were last on the show in 2019. You survived 2020, which is a huge compliment to anyone. You’re looking good. You had one of the most popular shows that year. So, kudos. Love the energy and vibe you brought and thought we’d catch up. Not a lot has happened in the last year or two. It’s just kind of been quiet, smooth sailing in Seattle and down here in LA. You guys surviving and everything up there?
Bill: Just a walk in the park. We moved our headquarters to Phoenix on July 1st.
Bill: I was quarantined here in the sunshine.
Meb: Well, it’s a beautiful place to quarantine. I’m fine as long as they keep the beaches open here, but when they closed those, life got very dark quick. All right. Let’s talk about you and I were rapping a little bit before we got started talking about clams. Do you want to tell the audience why we were talking about that?
Bill: Just from a historical perspective, it appears we’re in a tide change. And I have a family of razor clam diggers from the state of Washington. We go down to the coast. And there are certain seasons that you can clam. And when you go dig clams, the ideal thing is to dig at low tide because the clams expose themselves more with the low tide. And even at low tide, a lot of times waves can wash way up and drive you farther up the beach than you want to be just because of the natural to and fro of the waves. And it appears that we’re in a tide change between the revenue growth stories, the quarantine imprisonment glamour stocks, and the leaders of the next 5 to 10 years. And so I’d love to talk about kind of how that plays out.
Meb: I’ve had two clamming experiences. One was a total failure where we were driving up the central coast of California and for some reason I had it in my head that you could go clamming in Pismo Beach. And I went to the stores and I was trying to buy a bunch of equipment and the locals gave me the strangest looks you’ve ever seen in your life. But I finally got my fix, went to Alaska with my brothers and father and we did, I think it was razor clams there too. Had a really fun day. Problem with that is if you’re ever to Alaska, we’re outdoor trying to steam the clams, my God, the mosquitoes in the summer. You better bring like DEET 10,000 because the mosquitoes are the size of like small birds there. Love it there.
Bill: Air traffic control is required…
Meb: Yeah. Oh, my goodness.
Bill: …for those bugs.
Meb: Well, the thing about tides, and depending where you are in the world, they can be pretty significant. And they can come in, like you mentioned, pretty far. You’re a prolific writer. We love reading what you guys put out. A similar sort of piece where you’re talking about kind of what’s going on in the world. You start talking a little bit about the euphoria kind of things that are some signs. Maybe expand on what you’re talking about, some of these ideas and themes.
Bill: We went back this morning and took a look at what went on in the last two or three months of the dot-com bubble, and then the following year, and then two years, and then three years. So, value bottomed on about February 24th, but the NASDAQ peaked when Cisco reported earnings on May the 24th of 2000 at a $600 billion market cap, and with a huge price jump, not dissimilar to what Google is doing today, as a comparison 7% to 8%. And already the market was making the tide transition from a high tide for growth on its way to, at the bottom in ’02 and ’03, the bottom of the tide for growth and the bottom of the tide for tech. And the NASDAQ… What did we look at? The NASDAQ made 125% swing from the high point March 24th to the low point at the end of ’02. It went from up 50 to, whatever, 125% lower than that is, but along the way, made the stabs at reviving itself the same way the tide going out will have some waves wash up higher than you’d care to have when you’re on your knees trying to pull a razor clam out of the beach.
Meb: The analogy that I think is so apt from the 2000s, and you’ve talked about this before, is you have to distinguish between the business and the stock. Some of those world-class companies of the late… I mean, first of all, many didn’t survive. But some of the great ones, the Ciscos, the Microsofts of the world, survived, granted their stocks, in many cases, did very poorly, and some of them still below the peaks. And that seems to have some rhymes today.
Bill: We added Cisco to the… So, we looked at the Russell 1000 value, the NASDAQ 100, the S&P 500, and we added Cisco. So, here’s the numbers. So, May the 24th, it was the largest cap stock in the S&P 500 at $600 billion. And from that day till today, you’ve made 62 basis points a year compounded return on a Cisco for 21 years. And that counts dividends. And just looking back to ’04, the business has about quadrupled in the last 16 years.
Bill: So, what happens is you over-capitalize the business, and then they do succeed as an underlying business, and the investment becomes a dud. And that’s what the Intel’s and Cisco’s look like. Microsoft is a freak because it’s done so well in this particular media that it actually was a good investment, even though you spent 15 years making any money at all, which means that none of those humans actually participated in their success. It was a completely different set of investors that have made the money, all these fantasies about people staying in their chair. So, when it comes to glamour tech companies that get overcapitalized, the best you can expect from the successful companies is to not lose money over 20 years. And the worst is the Lucents, and the Sun Microsystems, and the GeoCities, and the AOLs. Steve Case was brilliant. He could see this coming. And what he did is he bought Time Warner and stuffed a brick and mortar company up underneath his market capitalization so that he could get more time to sell out, and did. He got hundreds of millions of dollars out because he stuffed a real company underneath an unreal company.
And so that’s the success stories. And of course, the misery stories are the revenue growth stories from that point in time that were just…they never filled in behind what they’re doing. And what causes so much trouble here is the pandemic is to this cycle what Y2K was to the last cycle, the thing that put the ridiculousness on steroids. The year 2000 changeover caused all the companies to have to buy new servers, new computers, new software, new routers, new phone equipment for the year 2000 changeover. And then that was the peak of business for a number of years. People should never forget, tech is cyclical. It has very long cycles, but it’s cyclical. And so ask yourself, “Are people going to be as dependent on technology anytime in the next 10 years compared to what they have been the last year?” And the answer is, the tide was high. Now, there are other things working along with this that are really fun and really cool. Warren Buffett and Charlie Munger say, “One of the blessings in life is to have very weak competition.” And Aswath Damodaran, the guy from NYU, said something brilliant a few days ago that I saw. People who are working on GameStop, they only want to talk about GameStop. And we’ve got a piece on our blog this week, and I compared Tesla to GameStop. And people can have some fun with that if they want to at smeadcap.com.
So, three things. One, the short squeeze on GameStop shows a loss of faith in experts. Two, unquestioning worship of crowd wisdom combined with empowering of crowds. And three, a conversion of disagreements in every arena in the personal and the political. Let’s just focus on the first two because the first two are more important for your audience. Whether it’s Jim Chanos, or David Einhorn, or whether it’s, not in their league, but Smead Capital, there is less respect for stock-picking experts right at this moment than there has been since the peak of the dot-com bubble. And the capital has all been pulled away from us. We run the least amount of capital. In other words, people that have effective long-term stock-picking disciplines that play out successfully over decade time periods have the least amount of capital. The best ideas they’ve had relative to the S&P in three or four decades, and Jack Bogle’s worst nightmare, which he warned us about before he died, is here, which he said that, last year before he died, he said, “I’m afraid my idea has gotten out of control.”
So, what’s happened is the wisdom of crowds has taken over and any financial advisor that can walk and talk and chew gum at the same time can stuff their client’s U.S. large-cap equity in the S&P, and they’ve been rewarded fabulously for doing so in the last tide movement. But we’re in the process at high tide and changing tides. And the statistical chance of that working in the next 5 to 10 years is 0 from a historical standpoint. So, that’s where all the capital is trapped. Of the 250 smallest stocks in the S&P, I think the market cap the S&P has what? Is it like 12% or 14%? Of the entire market cap, the S&P is in the smallest 250? And in just…in terribly disproportionate parts in the 25 largest. And therefore, the S&P is just a glamorized growth stock index. I’m interested to see in Berkshire Hathaway’s annual meeting if Buffett will say that he’s pulling his wife’s money away from it until it corrects because that is Kool-Aid drinking right now. Anybody that takes a widow lady and puts them in the index right now just added a stock that went up seven-fold called Tesla to their portfolio, 1.6% position. And any legitimate portfolio manager whose performance is measured would get fired for doing that.
Meb: We actually talked about this the other day. We were saying one of the biggest challenges and problems of the market-cap-weighted indices is they have no tether to fundamentals. And so when you have these sort of manias, some of these stocks can get to be a massive disproportionate part of the index and not even to the S&P 500, which you alluded to, but also a lot of people use these smaller funds. So, you can have these sector funds or even a small-cap growth fund where after what’s going on in the last couple of weeks, some of these stocks end up being 20-30% one stock. And then of course, what happens is it goes down 70% and you have both sides of it. We see a lot of concurrent indicators firing off that you and I have been around long enough that we’ve seen before. You mentioned the sort of retail involvement, some of Damodaran’s points. You got valuations. You have the crowd. We have SPACs.
Meb: Options trading. You got a great piece that was titled “WFH is a WKF.” And I was waiting for you to go dot-dot-dot WTF, which is a non-safe podcast acronym of what’s going on right now. Maybe talk to us a little bit about that piece, a little bit about, again, the current market. And feel free to reference anything over the last year or two. 2020, we kind of skipped over with you since the last time we had you on, but it was a pretty bananas year as well.
Bill: Anybody that’s interacted a lot with the service side of a company already knows that work from home is a nightmare for 80% of the companies. I have an old friend that ran a successful business for many years. He said, “Bill,” he said, “it’s not what’s expected that gets done. It’s what’s inspected that gets done.” And then secondarily, Barbra Streisand, we wrote about this a while back, her most popular song was from the play and movie “Funny Girl,” people who need people, “People who need people,” are the luckiest people in the world. I mean, would the show “The Office” be funny if they were on Zoom calls?
Meb: That’s a great one. Well, I mean, look… But the good news is on the Zoom calls, I get to see you. We get to hang out.
Bill: The pent up demand, people have no clue. Let me give you two examples. This will kind of segue into what we like because I’m tired of talking about what we don’t like because every time I talk about what we don’t like, the crowd drives it higher in price. So, let’s talk about a little bit what we do like. Let’s start with energy. And the beauty of investing is when economics makes sense and the market prices don’t make sense, in five years the economics always win. So, the bottom line is this. Forces are in place to significantly inhibit the future production of oil and gas. The primary ways that electricity is made are being significantly reduced, which is hydroelectric, not being done anymore, nuclear, not in my backyard, coal, it pollutes the Earth. And you get down to a few other ways. And guess what? Whether we power with gasoline or whether we power with electricity, our outlandish thought of the day two years from now, Joe Biden on TV doing a fireside chat, he’s got a cardigan sweater on, and he’s asking the American public to turn their thermostat down so that people in California can charge their cars. And the price of oil will be $100 a barrel.
And then on top of that, we’re going to get out of the pandemic through the vaccine and herd immunity and business people are going to go back to flying. You’re going to take on the 10% of the oil and gas that aren’t being used right now and it’s not going to be going back from 90% to 100%. It’s going to go to 100% because you got years of meetings to do in that 1 year. And the demand is going to go up. And the proven reserves sitting on the balance sheets of the continental resources and the Phillips’s and the Chevrons become dramatically more revived. Demand for their product is going to go up, and it’s just going to be the 1970s all over again. In turn, that and all the homes we got to build for all the millennials that finally got out of their selfish coma and recognize that it’s way better to have your own home is just beginning. Inflation is going to be rearing its ugly head and combining with this absolute insane flood of liquidity that the federal government and the Federal Reserve has provided, and we’re going to be back in the 1970s, which was a terrible time for the S&P 500 index, a terrible time to own anything other than things that benefited from inflation like real estate, like oil, like home building. The average citizen in the United States ends up at age 62 with the largest part of their net worth in their home. And the millennials waited till 30 to figure that out as compared to 25 for the baby boomers. So, we are just at the beginning of 90 million people wanting a home with 1.9 months of existing supply. Baby boomers are afraid to go to a nursing home. And the media won’t frame this right. They reported today, there are 16% more mortgages to buy a home than a year ago, and that’s before COVID hit, and there’s no existing homes to sell. It all has to be built by our DR Horton and our Lennar and our NVR. And those stocks are trading at 11 or 12 times earnings in 22 times S&P. This is insanity. It’s going to be the best industry in the United States in its 5 to 10 years. And the index has got 45 basis points in it.
Meb: Bill, you were actually all over this in our last conversation. So, listeners, we’ll link to this in the show notes talking about particularly the housing. And you nailed this even pre-COVID where you were talking about the migration of a lot of people away from the big cities to a lot of not second-tier cities, but smaller, not huge financial centres like a New York or San Francisco, but the Austins, the Nashvilles, maybe Denver. I don’t know if you count even Phoenix, Scottsdale, Tucson. Amazing places. And…
Bill: Albuquerque. Albuquerque, Reno. Then Des Moines, Indianapolis, you name it. Indianapolis got a brand new airport and homes half the price of the coastal cities. Detroit where everyone should have put their second headquarters has fantastic universities and private colleges feeding very well-educated young people into the system and an airport built about 6 to 10 years ago that’s absolutely a Cadillac and underutilized.
Meb: What’s nice about this is the intro of the conversation most investors would listen to the first few minutes and say, “Oh, my gosh, these guys sound like just total perma-bears, the sky is falling.” But in reality, through this discussion, we’ll touch on a few more, there are plenty of pockets of opportunity. You mentioned, by the way, the 1970s as a great warning. We haven’t had really any headline measurable inflation for a long time as bond yields have come down, but you’re starting to see certainly tick-ups in many places. A lot of the commodity complex has been making some serious moves this year quietly or not. But the homebuilding is one that just seems so obvious that the world… And then the homebuilding ETF has still done well, but is in many ways, it’s still cheap.
Bill: The thing that people have to understand is in the ’60s, the United States federal government did two things similar to what the effect of the COVID stimulus and borrowing and ultra-low interest rates did. We fought the Vietnam War halfway around the world with 500,000 American troops. And that was monumentally expensive, at the same time that President Johnson did what he called his great society, which was attempt through the federal government to improve the lot of the least fortunate in our society, which was very expensive on a federal government level. And then 79 million baby boomers got married and had kids and they were 75% more people than the silent generation right before them. So, what happened when way more people wanted the same things at the same time and they crashed into the liquidity created by that? It created double-digit inflation.
Now, the other thing that’s similar is what did we have happen last March and April with the Saudi Arabians? They jerked our chain big time. The Saudi Arabians jerked our chain big time in ’74, and again in ’79. History never repeats itself exactly, but it rhymes. You can see the rhyme, you can hear the rhyme. You can see the rhyme in the commodity markets. And the tide change hasn’t caught up in the stock market yet. So, therefore, the other thing I will say, and, again, I pick up my dog’s poop each day, it keeps me very humble, and I don’t want to say something that sounds unhumble, but one of the things that we feel blessed about at our business is the last 10 years have been unbelievable for growth investors and lousy for value investors. But we basically kept pace with an S&P that literally was almost impossible to keep pace with. So, one thing that we love about where we’re at is we have our confidence. Usually, when the tide changes, it takes the value guys two or three years to get back their mojo because their record is temporarily kaput. They own the right things in many cases, but they got no capital and they don’t really have a pitch because as soon as they pitch somebody they go, “Gosh. Am I got to touch that?” So, we just feel incredibly blessed because we don’t start this new tide movement, we start heading for the low-tide from the high-tide and don’t have to apologize for what we’ve been doing.
Meb: Well, in certain places like the natural resource sector, it’s not even low-tide, it’s like all the water has been drained from the pool or the ocean. I think energy at one point, you mentioned the ’70s, maybe ’80s was like 30% of the S&P and it’s now 2%, maybe it’s 3%, but it’s somewhere where it’s such an afterthought, it’s unbelievable
Meb: Oh, my goodness.
Bill: It was 29%-plus in 1981. And even the last 15 years, it, basically, one side or the other of 10% of the index. So, if by chance, the oil business is the best business in the United States of America, virtually, no one other than some overweighted value people are going to get that money.
Meb: And even if you mentioned, I mean, it’s so… We’ve done a lot of research, going back to the 1920s, on sectors and industries that get really bombed out, meaning they go down 60%, 80%, 90%. And same thing for countries and asset classes, but the industries and sectors tend to be more volatile, of course. And usually, when you get to be down that much, the close your eyes, hold your nose, and buy into something like that for a long period has been incredibly rewarding. And so the challenge is the time horizon on a world of trades and people wanting to trade this week, next week, options expiration next Friday, holding some for 3, 5, 10 years is a lifetime for a lot of people.
Bill: Your best buy is you’re putting the orders in and trying to keep yourself from vomiting at the same time. So, to go back, Jeff Bezos announced he’s going in the grocery store business in April, May, somewhere in there, in 2017. We he never owned Target. Target gets bombed along with the rest of them. Costco got bombed. Target got bombed. Target going through the low to mid-50s with absolutely as good a brand attachment to average and above average moms. And in the last 15 years, 60% of the college graduates are women. That’s in the last 20 years, the babies being born in the United States have moved from below-average incomes to above-average incomes. So, the moms and the money, that’s where it’s at and that’s where college-educated moms want a shot. And everyone doubted them even though that brand attachment was just as powerful as it ever was. Now, what we were fortunate enough to figure out was that having 1800 stores was going to be a huge competitive advantage in e-commerce. And the biggest mistake Jeff Bezos made in the last four years, he shouldn’t have bought Whole Foods. He should have bought Target. And then he wouldn’t be at a competitive disadvantage to Walmart and Target, but he is. But AWS covered all of that up for him by making a whole bunch of money, allowing him to sell his stuff at a loss, take away market share from people that actually have to compete on a fair basis.
Meb: Well, Jeff’s going to be shopping at the grocery store now that he’s got so much free time retiring CEO duties. We’ll see. He just focuses all his attention on building rocket ships or what? I don’t know. We’ll see. I think that’s a great point, though. You have, like, a five kind of themes that you’re particularly looking into. And I love what you guys do because you’re concentrated. You own usually about 30 stocks or companies. Does that fit in the broken growth stock category or is that more into sort of the real estate play? How do you kind of characterize the Targets sort of ideas?
Bill: The answer is, we love to buy a great company when it’s in the position of being a broken growth stock. Whole Foods was a broken growth stock, but the truth of it is, they had tried for three or four years to get it going again and they hadn’t. And so you could say that Amazon has got it going. But when you dig into what actually is going on with Amazon, it’s a pimple on the face of humanity. Four-hundred and fifty little stores are nothing in their scheme. Okay? Let me tack a little, since you mentioned Amazon, your viewers and listeners need to understand what the antitrust law is all about and how it’s going to affect security performance over the course of the next 10 years. So, John Sherman wrote the Sherman Antitrust Act, and he said, “Our wonderful exercise in democracy can only be ruined by a disturbance of the social order. And the most likely thing to disturb the social order would be the concentration of capital in vast combinations.” So, they broke up the railroads or regulated them. They broke up Standard Oil. They regulated AT&T. They regulated the broadcast companies. They regulated the tobacco companies. Yada, yada, yada.
The inequity in our society and our macroeconomic distribution problems are all tied directly to the fact that the big tech behemoths that have most of the capital concentrated in them do not have good multiplier effect attached to them. Let me explain. Not to pick on Apple, although, them raping our privacy deserves to be picked on. They have $15 million of revenue per employee. They do most of their assembly outside the United States. Their capital spending last year in the United States was $7 billion. Their employees live in expensive coastal cities, and therefore, their bartender, their maid, everybody else that services them has no chance of buying a car, no chance of buying a house, no chance of having the American dream. Now, let’s use our housing industry. As we boom in the housing industry, the carpenters, the plumbers, the electricians, the framers, the brick masons, the pavers, the architects, the… I don’t… You name it. There’s just zilli… The multiplier effect in homebuilding. You buy a $400,000 house, you take out a $320,000 loan. The bank puts 10 times the money in circulation that they have on deposit. The multiplier effect is unbelievable. And as people move away from those core inner cities and kick that multiplier effect, you can live…two people can make minimum wage in Safford, Arizona or Albuquerque, New Mexico, or Reno, Nevada, and they can own a home, it may be a manufactured home, but they’ll own a home, and they’ll have a good life. But you can’t do that in Seattle and you can’t do that in San Francisco and you can’t do that in core LA and you can’t do that…
So, dealing with their totally anti-competitive positions is critical to spreading the success of our society around. And there are people on both sides of the aisle that get that. And anybody in that world that wants to talk about it read Peter Doran’s book, “Breaking Rockefeller,” because most people don’t… Even the attorneys, they don’t understand the first thing of the purpose of that law. It had nothing to do with getting good prices. Nothing. Nothing to do with getting good prices. It had everything to do with ruining our society by a disproportionate amount of the success created by the society going to too small a number of people. And if that’s not what we don’t have right now, I’m two years old.
Meb: Well, Bill, I think having appreciation for history, particularly, economic history, one of my favorite things to do, this great book recently called… Oh, man. What was it called?” Capitalism like a 400-year history or something by William Bernstein and the late Peter Bernstein. A lot of these authors have written some pretty fantastic chronicles of the early part of the 20th century, but it’ll be fun to see what’s written after this period comes and goes and a few years as well. But I think those are important points. How do you think it plays out? Do you think the new Congress starts to lay the hammer and focus on some of these situations or do you think that’s lower on the list?
Bill: Well, the way it works is the animals have to get out of the barn first, and then they’ll close the door. Now, some people have tried to close it before the animals get out of the barn on both sides of the aisle. Denis C. Salini understands this subject. Josh Hawley on the right understands this subject. Elizabeth Warren actually understands this subject. But the likelihood is, it will be in the aftermath of the next bear market when they’re pointing fingers and mad at how poorly the tech stocks have done and led to severe stock market failure, I might add, which stock market failure is highly likely among 75% of people that participate in investments for the very reasons you and I’ve already talked about today. And so that will be the recrimination. It won’t be Occupy Wall Street, it will be Occupy Monopolies.
Meb: Good point. And so investment implications. Is it simply avoid some of those securities? Is it to just search elsewhere? Does it have broad market implications? What’s kind of the takeaway on those, wrapping a bow on that concept?
Bill: Every time I answer this question, I just look like a complete idiot. Okay? So, the first thing I’ll say is that…
Meb: I do that on the daily on Twitter, so don’t sweat it.
Bill: The first thing I’ll say is you can’t hold your breath until the thing trade dies. So, don’t try. But anybody that knows history… I mean, we’re drowning in the signs. I mean, literally, there’s more signs now than there was in ’99 at the end of the year. There’s some of the similar crazy stuff that went on then and a whole bunch of crazy stuff that never went on then that’s going on now. This one might be bigger. This might be more of a ’29 kind of thing. If you go back and study John Kenneth Galbraith wrote a book on the great crash. And Goldman Sachs wasn’t doing SPACs back then, they were doing these trusts that added leverage to owning what normally wouldn’t be very risky stocks, but by the time they leveraged it all up in the trust, it got pretty wild. And I’m not picking on them. They’re a great firm, but that’s what happens. So, yes. I mean, there’s going to be a lot of agony like there was in the ’70s and there’s going to be money made on the ground on Main Street in things that benefit from the inflation as people turn away from bonds and get crushed on anything outside of five years when the rates go up and watch the money gravitate to whatever insulates people from the coming inflation.
Meb: I was thinking about that as you were talking about the ’20s and, again, the 2000s, you get so many concurrent sentiment indicators. It’s always hard to people think they can always time the exact top. And the catalyst, in some cases, many bubbles, you can look back and find a catalyst, in many cases, you can’t. But what’s interesting about each one is when you’re talking about the ’20s earlier, I was thinking about Shiller had published a sector P/E ratio paper years ago that looked at a lot of indices going back for the better part of the century. And in the 1920s, the utility sector, the most boring possible sector you could think of today hit a long-term P/E ratio of 60. And fast forward a couple of years later, I think it was three. So, that just goes, like, the manic Mr. Market. You can get a bubble in the most… I have a tweet somewhere that talks about this and I list like 10 things that are the most boring possible things that have created bubbles. And I said utility stock is up there, but baseball cards, Cabbage Patch Kids, on and on and on.
Bill: Nobody thinks about… I got one for you. By the way, on January 1, we were just out of control COVID cases, 250,000 a day, out of control, and the numbers dropped like 80% in 6 weeks. And our securities are priced similar to what they were before the case has dropped off the cliff of the things that would benefit from our economy going back to more normal. And it’s just hard for people to imagine. How about this? Will someone get sick to their stomach in a year and a half if they go out to their door and they see three or four Amazon deliveries at their doorstep because it reminds them a brand in prison for a year? So, they don’t want to own our mall stocks, even though 15 to 25-year-olds aren’t going to need to go someplace to find each other as soon as this is over. They don’t want to own the mall stocks. By the way, the malls are in affluent suburbs, which is the first place people from the core downtown flee to. So, New Jersey is the big winner at the expense of Manhattan. And an hour and a half away from San Francisco and… That’s the first move. An hour and a half away from Seattle is the first move. And as soon as you move from the core when you do want a brick and mortar shopping experience, you don’t go back to Downtown San Francisco or Downtown Seattle. You’ll go to the mall that’s 20 minutes away from you. We saw a picture… We own Macerich, and they have the highest amount of population within 10 miles of their A malls of the A mall owners.
So, having wonderful property in the most affluent places in the United States of America in the suburbs, I don’t care what you end up doing with the property, the property is going to be a bonanza. Here’s what it reminds me of. By the way, it reminds me of in the movie, Scarlett O’Hara, things are terrible. Things are terrible and Scarlet is hearing her dad who’s dead and he’s whispering in her mind. And he’s saying, “Go back to Tara. Go back to the land. It’s the only thing that lasts. It’s the only thing that lasts.” Land is severely undervalued right now. Oil is severely undervalued right now. That is the magic of this thing. And people are just…they just don’t have any ability right now to visualize the pandemic becoming the flu. That’s where we’re going. It’s going to be something that you get vaccinated for in October each year for when you’re stuck indoors breathing the same air over and over so that you don’t get it. And that’s what it’s going to become. And everyone’s going to want to go to the football game. Everyone’s going to want to go to the NBA game. Everyone wants to go to the baseball game. They’re going to want to do everything they couldn’t do, not what they did.
So, last thing on that. People think in growth, “Oh, yeah, I’m going to stay away from that rich C-R-A-P that’s going to scald people and I’m going to own my 35 times Costco, and my 35 times Visa, and my 35 times MasterCard, and all the other 35 times slow growth very mature companies and not own the American Express in 14 times earnings. I’ll own the 35 times one that wasn’t affected because of all the things we bought stuck at home.” And then when we get out of being stuck at home, the credit card company that does get those travel charges is going to be the glam credit card company. When inflation rears its ugly head, growth multiples will contract severely. Your 35 times glamour Costco will go back to what it used to be, which was a 15 to 20 multiple stock. It’s a great company, but as mature as it is and as much inflated as their sales and earnings are by the prison, it’s not a good time to invest if you’re a long-term investor. You want to wait until those P/E ratios contract.
Meb: I was thinking as you were talking about this, two thoughts came to mind. One, is the recent disclosure that Bill Gates is now the largest owner of land and particularly farmland in the United States. So, he’s been buying that up over the last few years. Second is that, I wonder how much of a counterbalancing factor as we think about the final tide on this bull, you have this rush back to normal life, and so everyone’s going to be out just spending all those stimulus checks and eating out and going to the mall. But the countervailing force as far as markets is no one’s going to be home trading and investing all day anymore because they’re not stuck at home. So, I wonder if you have the economic boom, but the stocks go down. I don’t know.
Bill: You got to love the millennials. They all should have bought a house seven years ago and they missed that because they drank the Kool-Aid and thought it’s a good idea to stay single for a long time and then have a real hard time having babies in your late 30s. And now they’re late to the party buying the homes. They all think they’re so genius in all this stuff, including stock trading. Why the heck weren’t they doing Robinhood eight years ago? And the answer is because they’re going to fail and they’re going to stay away from the stock market for about 15 or 20 years because they’re going to fail on what they’re doing here.
Meb: They have a really tough starting entry point.
Bill: Oh, miserable.
Meb: I talked to some investors in Japan a year or two ago when I was last there and we did a little fun, happy hour meet up. And it was just talking about the general concept of buy and hold. And Japan has had no stock returns for 30 years. It’s breaking out now and it’s been doing well over the last couple years, but, essentially, for an entire generation of investors that bought after the 1980s, you had no return. So, you have an entire generation that, like, buy and hold is not a concept because it’s returned them nothing. And so the starting points, it’s unfortunate, I said this on Twitter the other day, I said if you’re a young person, particularly young, I said the best possible thing that can happen to you is a 50% to, God forbid, 80% bear market because then all the future stream of cash flows reset and you get to save and invest at a low price. But the problem is that also usually dissuades people from investing because they see what happened. Why would you buy something that goes down? You lose money and rinse, repeat. Cycle starts anew.
Bill: The beauty of it is, and this probably should be my final point, it is that life is not designed for the majority of people to do well on getting rich slowly because Buffett likes to say that the first investing concept was Aesop who said, “A bird in the hand is worth two in the bush.” Well, the two in the bush have been clobbering the bird in their hand for, like, seven years in a row. And these young people had been taught that the two in the bush win. And they’re better off when they turn 50 to have had this experience. I’m glad they had this experience. I’m sorry they’re going to get clobbered. And they are going to get clobbered. And then they will turn away from the stock market and they’ll be much more interested in houses, which is, really, they’re much more likely, any investment you’re forced to stay with for 10 or 20 years is likely to be better than something you can come in and out of. That’s just the way life works.
Meb: We’ve talked about three general themes. It’s this nice foil and contrast where we were talking about the challenges of investing in the general market, but you’ve mentioned…we’ve talked about broken growth, we’ve talked about real estate, oil, and gas. There’s two other general themes that you’ve talked a lot about, that being banks and biotech and pharma. Any general quick hits you can give us on some of those ideas? And feel free to name names if you want to.
Bill: The inflation in the ’60s and early ’70s worked in the favor of the major banks. Their credits, their spreads got better. Activity. Right now household balance sheets in the United States are the best they’ve been in the entire 40 years that the Federal Reserve has been measuring it. A concept that we have understood for a number of years now is the millennials are going to go from single and primarily discretionary spenders, other than rent, to married with kids and primarily necessity spenders, and our portfolio across the board is built around that necessity spending. So, Target is a beneficiary of the necessity spending. We’ve done well on it. At 22 multiple, could its P/E ratio contract? Yes, but they’re in the sweet spot the next 10 years on the demographics. Kids clothing. Children need a new pair of shoes every 90 days, either outgrow them or wear them out, kind of thing. And necessity spending becomes the model. And discretionary has been where it’s been at. And there’s no multiplier effect in discretionary spending. And there is a huge multiplier effect in buying homes, buying cars, having kids, living life. And Bill Clinton soccer moms will be the main voting constituency in about 5 to 10 years.
Meb: And so are there any particular names you think look pretty interesting as far as the banks? Is it that you could just buy the ETF and be done with it? Is it sort of the regional? Is it the big, huge ones?
Bill: We own Bank of America, JP Morgan, we own American Express. American Express has… When the business traveller goes back to travelling and the leisure traveller goes back to travelling, it’s overwhelming what will happen to American Express. It’s almost overwhelming to think about how much leverage because they did pretty darn well just kind of keeping on keeping on but their earnings leverage will be incredible. And the velocity of money is going to pick up a lot. That’s part of what causes inflation is you got all this liquidity, you got 90 million millennials, and then the money starts turning over a lot faster. And that’s good for the banks, big banks. Yes. And lastly, before we get done, the other area that looks like a great reopening trade is getting people to go back to regular doctor visits and the prescriptions that get issued for Amgen, Merck, Pfizer. Those stocks are cheap in relation to the index. You’re buying them at the prices they trade at in a bad market era, in a good market era. And they are a beneficiary.
Now Amgen reported yesterday the stock is down today, which is, in my opinion, just goofy. But what they said was, they’re kind of low-balling their numbers for revenue because they don’t know how soon they’ll be able to get back into the doctor to get their prescriptions, new prescriptions for people that have osteoporosis. Women between 50 to 80 haven’t been going to the doctor and getting fresh diagnosis of osteoporosis to get Prolia prescribed to them. And that’s going to happen. The first vaccines are going to them. So, there’s unbelievable reopening leverage. And the stocks… And everybody hates them because they’re worried about prices. How about volume? Volume would be good. And by the way, they’ve grown their earnings anyway. On this year’s earnings, the stock trade is about 13.5 times earnings, pays a fat dividend, Amgen does. Merck has got Keytruda curing cancer, going to move to the other major cancers with their science, pays a fat dividend. I mean, fat dividends. The 10-year treasury has to triple to get up with the dividends you get from those folks.
Meb: Dividends. Who cares about those? It’s boring. It’s boring, Bill. I can make that sort of returns in a day. As you look to the future, 2021, it’s weird to say, as all this plays out, anything else you’re thinking about, writing about on your brain? Any rough drafts we can peel back the onion about or anything that’s got you scratching your head or curious, excited about?
Bill: I think we pretty much covered. You might have exhausted me. If I was 15 years younger, I might have had a little bit more in my tank, but I think you’ve done a good job. And by the way, thank you. Your methodology here is just wonderful. I love to communicate…
Meb: It’s to chat with fun people, Bill. It’s just like happy hour remote now. And hopefully, what do you think, Q3, we’ll be able to do these in person?
Bill: Oh, wouldn’t that be great?
Meb: I hope so.
Bill: I look forward to it.
Meb: Fingers crossed. Where do people go if they want to find some more of your writings, keep up to date with what you guys are doing? Where’s the spot?
Bill: smeadcap.com. Smead blog in smeadcap.com. Sign up for it. You don’t have to read it. We’re having as much fun as you can just about stand even last year when we’re getting our heads kicked in. People get on our webcast each quarter and they say things like, “Well, I got to give you credit, you’re saying the same thing.”
Meb: It’s a compliment. They may not admit it, it’s a compliment but it’s a compliment.
Bill: We take it as a compliment.
Meb: Well, good. I’m excited to order some clam pasta tonight for dinner. We’ll add show notes links to all your writings, everything else in the mebfaber.com/podcast. Bill, thanks so much for joining us.
Bill: Great to be with you. Blessings to you.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at firstname.lastname@example.org. We’d love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.