Smead International Value Fund commentary for the second quarter ended June 30, 2024, titled, "Our Edge."
As the investors of the strategy look back at the first half of 2024, we believe it is important to understand where we sit and what our edge as investors is. With the barrage of news and noise today, we want to focus in on how we can take advantage of the markets.
The year 2024 has been a continued narrow US market dominated by the S&P 500 and big-cap tech. Europe has put up a strong return at 8% (as noted by the MSCI Europe Index), but has been overshadowed by the MAG 7 and all things AI. Our advantages do not lie in the ability to predict the timing of events. We could no more tell you whether Europe’s returns were going to be good this year or when the next bear market in the S&P 500 will begin.
The investors of the strategy use the investment discipline of Smead Capital Management to invest. The foundation of that discipline is the firm’s eight criteria. These criteria, more than anything else, limit what we can invest in. Investing is a negative art. You are trying to eliminate potential investments that don’t fit what you do, which allows you to spend all of your time on the ones that couldn’t be eliminated.
This brings up our first edge in the strategy right now: we are focused. We are focused on the reserve life of our oil and gas assets in places like Canada with investments like MEG Energy (MEG CN), Cenovus (CVE CN) and Strathcona (SCR CN). In a world that is far less interested in investing in energy compared to AI, we believe that the assets’ lives need to match the current long lead time capital cycle. Many people are investing in energy, but not as many are as focused as we are in the space.
Our second edge is our belief in change. We are all being drowned in the conversation of how great and big AI will be and how it will change our lives. We are pragmatists and agree with this line of logic. Did the internet change our lives? Yes. Even the luddites have smartphones now. Why did this become adopted? It was because the cost of the internet and smartphones have gone down massively for 24 years, while the product has gotten better and better. We accept that AI will produce a huge volume of use, but the price per unit will decline like every other technology.
In comparison, the same people who believe our lives will change with AI are very unaccepting of the change that can happen in the stock market. Below is a look at US household ownership of stocks versus the forward 10-year S&P 500 returns:
The futurists preaching that these technologies will grow are not willing to accept the change that will come with low forward stock returns. Both are departures from the past when we had far less AI and great stock returns as noted by the S&P 500. Our investors are not taking this risk of change as we don’t own a portfolio similar to the index.
Our last edge is respect for an unknown future. The future is always unknowable. This should create uncertainty that keeps things discounted on a constant basis. However, this discount isn’t constant. When stocks do well, investors feel the future is more known. When they go down, they feel the future is less known. As investors, we must always remind ourselves that the future can’t be known.
Investors believe that Russia is not a continuing issue, for example. As a person born in 1983, I’ve never seen a major power enter a direct conflict in my life. Russia is completely outside of the box of what people thought could happen. Even while troops built up on the border in late 2021, investors never thought that Russia would invade. They all learned about the unknown future.
Based on the current headlines, you can see that investors believe that inflation is now at bay. Below is a look at what inflation did during the 1970s and what Fed Funds rates did.
This bias leaves us in the camp of believing that there is still an unknown future for inflation. However, we do know what US federal government spending is. We take heed to what Warren Mosler, one of the MMT proponents, said in a recent interview. Here’s the hot take:
Mosler called the 5%+ deficits of today “drunken sailor” levels of government spending — which for anyone who’s been following MMT folks, isn’t out of left field. After all, when that deficit money floods out into a economy operating at capacity, it pushes up the price level.
So that’s where MMT is on this issue: real resource constraints like we have today lead to inflation.
While the future is still unknown, but people are not worried about government spending at high levels. The highest correlation that comes with it is inflation. This is a solvable problem, but no one cares to solve it now.
As we cast off to the second half of the year, we believe our focus, our belief in change and our respect for an unknown future will advantage our fellow investors. This is a compelling time to put our edge to work for our investors.