The widely held view of the U.S. economy that dominates the media today is cautious. While housing prices are rising and the employment picture is improving, the pace of progress has been slow on both those fronts. The debt cloud hanging over the federal government and individuals won’t disappear for many years, and in the meantime, U.S. consumers will be timid buyers.

William Smead’s view is vastly different. According to the 56-year-old manager of the Smead Value Fund, the most powerful trend driving economic expansion is one that few people are looking at: people now in their 20s and 30s. Like reports about the slow-growth economy, news about these “echo boomers,” focuses on challenges such as struggles with mountainous student debt and high unemployment. Yet their role as a powerful consumer block is largely ignored.

“In the 1980s, the buying power of the baby boomer generation helped lift the country out of recession,” he says. “Today, the things their children purchase for weddings, furniture and housing and other items will have a huge multiplying effect for the economy.”

The impact is only starting to be felt. In a recent report from his firm, Smead noted that there are 86 million people between the ages of 18 and 37, with an average age of 28 years old. Women marry at an average age of 26.9, men at 28.7. “This means a slug of babies are coming as a byproduct of these unions,” he says. “We see that as a key to economic growth.”

As for the well-publicized hardships echo-boomers face, such as high student loan debt, Smead labels them “urban myths.” “People who borrowed to the hilt to go to the most expensive private schools are skewing those numbers,” he says. “Someone who went to a state school might have $20,000 in student loans when they graduate. That’s not horrendous. The fact is, today’s echo boomers have better balance sheets than previous generations. And with the U.S. population at 315 million, they are now a bigger economic factor than the baby boom generation.” He believes the buying power of the echo boomers, along with low inflation, gives the stock market further running room despite valuations that are at or near historic averages.

He’s not quite as optimistic about how the commodities market will play out. Over-planting and over-production, he believes, “will lead a decade-long bear market in commodities” that will bottom out once prices fall to the cost of production. He observes that with oil costing $50 per barrel to produce, there is ample room on the downside. On the bright side, lower commodity prices should stimulate the economy.

As a contrarian, Smead looks for trends, such as the echo boom generation or the deterioration of commodity prices, which most people aren’t paying attention to. He plays those themes using the stocks of companies that have good earnings prospects but are selling at below-market valuations. Because of those value leanings, the portfolio trades at an average of 14 times estimated 2014 earnings, slightly below a level of about 15 times earnings for the S&P 500 index.

Companies must also have a strong competitive advantage, such as high barriers to entry, a long history of profitability and strong operating metrics and a high level of free cash flow. Shareholder-friendly moves such as dividend increases and stock buybacks are also pluses. Smead’s loyalty to his picks is reflected in the fund’s low 11% turnover.

These criteria weed out stocks in capital-intensive industries that have high debt levels, including those in the energy, basic materials, heavy industrial, utility and telecommunications sectors. He also avoids what he considers overbought “new era” concept stocks such as Amazon and Zillow, as well as IPOs for hot glamour companies such as Facebook and Twitter.

Most small company stocks don’t appeal to him either. Over the last five years, institutional investors have been piling into them because of their strong performance and “the beauty of hindsight via rearview mirrors.” At the same time, these investors have been cutting back investments in large-cap U.S. equities. The imbalance, he says, has created much more reasonable valuations for the latter group. He believes the large caps, particularly those in the fund’s portfolio, will likely hold up better than more speculative small and mid-cap securities in a market decline.

“The history of the financial market shows that the best long-term returns come from large-cap U.S. stocks,” he says. “They are also the most liquid in the marketplace. A lot of investors aren’t enjoying the full benefit of the easiest thing to do.”

Whether or not Smead’s optimistic vision for the economy and the portfolio’s assemblage of 28 stocks proves accurate, the fund’s six-year performance history supports its methodology thus far. Over the last one-year, three-year and five-year periods ended March 31, it was in the top 24%, 1% and 5% of funds in Morningstar’s large blend category. From its inception in January 2008 through the beginning of April, a $10,000 investment in the fund would have grown to $16,204, compared with $14,768 for the S&P 500 index.

A former financial advisor, Smead credits at least part of the fund’s success to the bear market that began a few months after it opened its doors in 2008. After many years as a portfolio manager for wealthy investors and institutions, he decided it was finally time to give his investment philosophy and strong investment record broader play through a mutual fund, a goal that he began formulating about a decade earlier. “Other large-cap funds got filleted,” he says of the year in which his nascent fund took a sound beating as well. “People who already had successful funds got gun-shy. That leveled the playing field for us because we were willing to step in.”

Capitalizing On The “Addicted Consumer”
In line with his echo boomer theme, Smead’s portfolio is heavily skewed toward stocks that satisfy consumers’ appetite for certain products or services that aren’t considered “necessities.” These consumer discretionary stocks, which he believes will continue to grow with the economy, represent about 35% of the portfolio—nearly three times the 12% weighting for the S&P 500 index.

A major theme among these stocks is what he calls the “addicted consumer.” The phrase refers to consumers who are drawn to a broad range of discretionary products and services from companies with strong brand-name recognition.

Lately, investors have been flocking to consumer staples industries such as beverage or food because of the inelastic demand for their products or services. However, certain companies in the consumer discretionary category have a broad, loyal and consistent audience yet sell at less-pricey valuations than consumer staples companies. And they have a better shot at earnings growth. “Stocks such as Disney, Starbucks or Comcast have a very strong addicted consumer base, yet they trade at a significant discount to consumer staples companies such as Proctor & Gamble or Coca-Cola,” he says. “These are really consumer staples stocks in disguise.”

The fund’s largest holding, media company Gannett, is one stock in the consumer discretionary category that many have written off because of the negative impact of the downturn in the economy and slow pace of the recovery. Smead feels such pessimism has overshadowed Gannett’s strong and loyal audience base. “Gannett owns 40 network affiliate television stations and 84 local newspapers,” he says. “If a national advertiser wants to get exposure, it has to go through Gannett’s toll bridge. And people will always read community newspapers to catch up on local affairs.” The stock, which trades at just 10 times earnings, “gushes cash flow and provides great leverage on the economic comeback in the U.S.”

At 25% of assets, financial services represents the second-largest sector in the portfolio. Fund holding H&R Block, a stock in this category, is the largest and best-known tax preparation firm in the U.S. Despite wrestling with the divestiture of its poorly performing stock brokerage, mortgage lending and accounting divisions over the last 10 years, the company remains a tax preparation powerhouse. Many of its customers are middle-income consumers who don’t have their own accountants and who prefer not to deal with filing their own returns. Others use its tax software. “With blue-collar employment likely to pick up as commercial and residential construction make a comeback in the next 10 years, H&R Block should maintain high and sustainable profitability,” says Smead.

Another stock in the financial services category, Franklin Resources, is best known for its international mutual funds. However, both the stock and the firm’s fund assets have been hit by investor fears about China and the emerging markets. Smead points out that Franklin has a huge cash hoard that it will use to promote its well-regarded yet under-recognized U.S. domestic equity roster of offerings.

One of the fund’s newer additions, Chubb Group, is a property and casualty insurer that should benefit from the rebound in commercial and residential real estate. “Chubb takes great care of its independent agents. It’s the Cadillac of the industry. And it sells for just 10 times earnings and has an attractive dividend.”