By
William Smead
:
The Bible is full of stories of God's people living in exile on
their own volition. A famine occurred in the land of "milk and
honey," so the Hebrews moved to Egypt at the time of Joseph. The
father-in-law, brother-in-law and husband of Ruth left Israel to
live among the Moabites during a famine. Mordecai and Esther lived
in Babylon among the Persians, even though God called his people to
rebuild Jerusalem.
We at Smead Capital Management (SCM) believe that institutional
and individual investors have moved their asset allocation away
from large cap U.S. stocks. Institutions are in exile in private
equity, hedge funds and all things commodity and BRIC-trade
related. Individuals are living in bond land and the rest of their
liquid assets are residing in wide asset allocation through funds
and
ETFs
.
Why did the Hebrew people get into so much trouble? They didn't
rely on God's promise to take care of them even in famine. The
Israelites stayed in Egypt long after the famine ended in Israel
and ended up slaves to Pharaoh. Ruth's male relatives dropped dead
among the Moabites, stranding their families. Mordecai allowed his
adopted daughter to sleep with the King. She became Queen and used
her leverage to keep Haman from slaughtering all the Jewish
people.
A famine occurred in the U.S. stock market from March 10, 2000
to March 9, 2009. It was teed up by the 1990s tech stock and
large-cap growth stock boom. This triggered a movement out of
long-only U.S. large-cap equities. According to the NACUBO studies
done in 2010 and 2002, the pool of endowment funds sampled had only
15% in U.S. Equities on a dollar-weighted basis in 2010 vs. 36.7%
eight years earlier.
In the aftermath of two 40-plus percent U.S. stock market
declines, investors exiled themselves voluntarily. We believe they
lost faith in the best performing liquid asset class because they
don't think the ups and downs are worth the historically-superior
return. Stocks have recovered nicely, while individuals loaded the
truck with bond funds. According to the Lipper organization, U.S.
mutual fund investors have net-liquidated U.S. large-cap equity
mutual funds for 40 consecutive months. Institutions loaded up on
illiquid private equity investments and what we believe are
super-risky commodity/BRIC-trade related investments after 10 years
of red-hot performance. Those returns were high both historically
and compared to U.S. large-cap equity indices. Again referring back
to the NACUBO studies, endowment funds increased their
participation in alternative strategies from less than 20% in 2002
to 52% in 2010 on a dollar-weighted basis.
Why did the Hebrews stay in exile? They got comfortable with the
early years in exile, but the decline in their circumstances was
subtle and incremental. We like to think that institutional and
individual investors are like frogs put into a pot of water set to
heat to the boiling point. At first, the temperature is fine and it
slowly heats up. Eventually it gets so hot that it is unbearable
and the owners scream, "Get me out of here!" The chart below shows
how poor the returns have been over the last 3 years for the kind
of asset allocation that existed in the latest NACUBO study
(compared to a 60/40 stock bond mix, let alone 100% U.S.
equity).
(click to enlarge)
Source: New York Times, October 12, 2012
THERE IS NOTHING TO INDICATE THAT THE FROGS ARE JUMPING OUT OF
THE POT. In our opinion, the more years it takes for people to come
back out of exile, the more imprisoned investors are going to feel
by their portfolio makeup. For example, trying to make a retirement
living out of U.S. treasury and certificate of deposit interest
rates is like building pyramids out of straw!
The U.S. stock market can have a significant correction at any
time and most likely will every year. It is likely to suffer a bear
market once every 5 years on average. Those mini-famines are the
price you pay to earn 8-10 percent over long-term holding periods
(15-20 years). We aren't concerned about the short-run outlook for
U.S. stocks because most of the money hasn't even begun to come
back from voluntary exile. When commodities and bonds inflict pain
on the investment frogs, prices could be quite a bit higher for the
kind of companies which fit our eight proprietary criteria.
Disclaimer:
The information contained in this missive represents SCM's
opinions, and should not be construed as personalized or
individualized investment advice. Past performance is no
guarantee of future results. It should not be assumed that
investing in any securities mentioned above will or will not be
profitable. A list of all recommendations made by Smead Capital
Management within the past twelve month period is available upon
request.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
There's No BLS Without 'BS'
on seekingalpha.com