The fourth quarter of 2022 was strangely rewarding in a very difficult year in the stock market. The Smead Value Fund (Trades, Portfolio) (SMVLX) gained 13.72% in the quarter versus a gain of 7.56% in the S&P 500 Index and a gain of 12.42% in the Russell 1000 Value Index. For the year 2022, the Fund lost 2.78% versus a loss of 18.11% in the S&P 500 Index and a loss of 7.54% in the Russell 1000 Value Index. We are referring to this as a “nasty bear market” for obvious reasons.
Our favorable quarter was led by Merck (MRK, Financial), Macerich (MAC, Financial) and Simon Property (SPG, Financial). Merck was a tower of power all year as investors decided that curing cancer was a worthy endeavor and there are many cancers left to turn immuno-oncology loose on. Macerich and Simon bounced off very depressed stock prices at the end of Q3.
Detractors for the quarter were Warner Bros Discovery (WBD, Financial), Ovintiv (OVV, Financial) and Qualcomm (QCOM, Financial). Warner has drowned in the disappointment of the food fight in the streaming world and the disintegration of the cable food chain monopoly. However, they are the low-cost producer of TV and movie entertainment (if that ever becomes valuable again). Ovintiv suffered from being added to our portfolio late in the year, as it replaced part of what we owned in Continental Resources (CLR, Financial), just as the current correction in oil stocks began Continental got bought out from under us in the fourth quarter.
This leads us to our biggest contributors for the year 2022. Continental Resources (CLR, Financial), Occidental Petroleum (OXY, Financial) and Conoco Phillips (COP, Financial). OXY was the best performer in the S&P 500 Index in 2022, so imagine how much CLR went up to make a bigger contribution to our return. When I tell you that I have considered changing my name to Jed Clampett, don’t think I’m kidding!
For the year, Warner (WBD, Financial), Target (TGT, Financial) and eBay (EBAY, Financial) cost us the most. Warner’s struggles were already mentioned, while Target and eBay suffered as the bloom came off the growth/tech stock rose. We have held these stocks for years and believe they have a bright long-term future.
Overall, we felt very blessed to have preserved most of our capital in a bear market that didn’t fool us.
Shame on Me in 2023
The old adage says, “Fool me once, shame on you. Fool me twice, shame on me!” We at Smead Capital Management believe the stock market wants to cause stock market failure by being extremely difficult in 2023. Most investors were fooled in 2022 by expecting circumstances similar to the prior ten years. Now, most investors have leaned into the idea that the 18.17% decline in the S&P 500 for the year 2022 is a one-and-done.
One of the keys to successful investing is being rational. Here are a series of reasons to expect difficult 2023 waters in the S&P 500 Index:
1. Charlie Munger (Trades, Portfolio) called the financial euphoria episode which ended in late 2021 the biggest one of his career, because of “the totality of it!” We have analyzed the unwinding of prior major euphoria episodes in 1929, 1972, 2000 and 2007. The abuse to maniacal bull market darlings lasted two to three years and took an even bigger toll on the index than the 2022 year did.
2. Watching QQQ commercials on television and seeing growth stock portfolio managers and analysts lean into buying dips in the former glam tech stocks matches up with the prior episodes. Polaroid got pummeled for three years in 1929-1932. Disney and Coca-Cola were torn apart in 1973 and 1974. Microsoft, Cisco and Intel got crushed by the entirety of the 2000-2003 bear market and were dead money for ten to twenty years.
3. Stocks are not cheap as a group. The current stock market is expensive on a price-to-earnings ratio basis compared to previous bear market low points. The difference in 2003 was interest rates were headed down and not up like they are now. Second, most of the 2000-2003 bear market abuse was in technology, telecom and dotcom stocks. There were multiple industry groups that made money during the 2000-2003 bear market and very few in 2022.
4. Interest rates haven’t fully normalized. It is hard to visualize the stock market starting a new bull market until the Federal Reserve Board finishes tightening credit to address what they use to think was “transitory” inflation.
5. Sentiment is bearish and favorable under normal conditions. However, the analysts who cover FAANG and other glam tech stocks have not given up. At the bottom of the 2007-2009 bear market, 80% of those polled thought the Dow Jones Industrial Average would go dramatically lower when asked in March of 2009 near the bottom at 6500.
6. Commodities look very attractive relative to stocks and that doesn’t bode well for equity performance.
Our Goals for 2023
1. Avoid stock market failure by being preoccupied with defending our capital. We will look for an even larger “margin of safety” than normal. We will get that by using lower-than-consensus earnings estimates and calculating net present value using much higher than current ten-year Corporate Bond rates.
2. Bet that the largest population group (millennials) will use most of their income on necessities and reduce the kind of discretionary spending they did as single apartment dwellers from 2010-2020. We see homes that need to be built, cars made, children born and all the spending attached. We also see them spreading out across the country to arbitrage land values.
3. We will invest in scarcities. Fossil fuels will be needed for decades, not years. We will join President Biden in buying all the oil in the ground we can find. We will build homes nationwide and own land with premier shopping, restaurant and entertainment facilities. If it looks to you like we believe in ongoing inflation problems, you guessed correctly.
4. As we always do, we will invest based on superior long-duration performance. This means ignoring short-run difficulty to get at the future income streams over the next ten years. We must act and think like owners of these businesses because we are partial owners of them.
In summary, we are looking for bright futures among companies that meet our eight criteria for stock selection which are aligned with maximizing returns from necessity spending in an inflationary environment. Thank you for your confidence and trust in our portfolio management discipline.
The information contained herein represents the opinion of Smead Capital Management and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice.
