What is an investor with a five-year time frame to do?
Investors are punishing economically sensitive stocks because of the flattening of the yield curve and fears about the length of the current economic recovery. This is opening some doors to us in stock picking for long durations.
First, the flattening yield curve is happening at extremely low interest rates and is being driven by very suppressed interest rates in other major economies (Germany, Japan, etc.) and the unwinding of the stimulus provided at the heights of the financial crisis. I have been in the investment business for 38 years and we have witnessed what genuinely difficult interest rate environments look like and this doesn’t look like one of them.
Second, this has been the most anemic economic recovery in my lifetime. The anemia was tied closely to the fact that housing was a negative contributor to GDP from 2008-2015. We’ve never had a vigorous economic recovery off the depths of a recession without homebuilding being a major positive force.
Therefore, we are two years into the recovery that is including homebuilding and we are only up to homebuilding activity that would be typical at recession lows in prior decades. We believe the best is yet to come and those expecting an end to this economic cycle look foolishly premature! Just look at the demographics. Household formation has taken off among Americans in their 30s and the chart above reminds us that a slug of new home-owning households is on the way. It is going to be very hard to recess the economy as the largest number of adults ramp up their economic activity.
Let’s tie this all together. We have no urge to chase popular securities, whether it be anything tied to China’s economic growth or tech-based financial euphoria. What we do want to do is bet that people 27-years old will be 35 in eight years. It is our kind of margin of safety.
We own two homebuilders, NVR (NVR) and Lennar (LEN). This appears to be a favorable entry point as they satisfy under-built home markets nationwide. Entertainment juggernauts like Discovery Inc. (DISCA), Disney (DIS), and Comcast (CMCSA) are begging us for capital and have leveraged themselves to millennials forming millions of households with the best content and Internet access. Lastly, the big banks could benefit from this future economic activity as their moat has grown massively. The number of banks and branches has shrunk as younger Americans have led the way on mobile banking dominance. We own Bank of America (BAC) and American Express (AXP) and love the possibilities of the recession fears being over blown.
In conclusion, it takes humility to stand against the crowd and it is very uncomfortable to avoid popular securities. However, we are excited about the long-term returns that some millennial optimism could provide, knowing that patience is required to gain the benefit from our contrary stances.
William Smead is CIO and CEO of Smead Capital Management.