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‘Inflation will be the subject matter that turns the market’: Bill Smead

Yahoo Finance’s Julie Hyman, Brian Sozzi, and Myles Udland break down today’s market action and 2021 outlook with Bill Smead, Smead Capital Management Chief Investment Officer and Co-Portfolio Manager.

Video Transcript

MYLES UDLAND: We're five minutes away from the opening bell on this Monday morning. It's been a strange last, really, 10 months in markets. And it's been an interesting start to 2021. Joining us now to talk a bit more about that is Bill Smead. He is the Chief Investment Officer and Co-Portfolio Manager over at Smead Capital Management.

Bill, it's good to speak with you once again. Let's just start with your overall view on what's happening in the market today. The move we've seen across the board, all kinds of styles, sectors, asset classes since, really, the election seems to have taken some folks by surprise and certainly puts us in an interesting place as we head into earnings season.

BILL SMEAD: Yeah, the market can stay insane longer than you can stay solvent, as a general rule. And I've seen a lot in 40 years in the business. But some of the things we're seeing lately are-- even would have been even considered wild in the year 2000.

BRIAN SOZZI: Bill, your message to GameStop investors, been a heck of a ride for them. Clearly, they might know something that everybody else doesn't. As a value guy, what do you tell them today?

BILL SMEAD: Well, first of all, when is the SEC going to step in and stop people from gathering in, basically, a chat room, like the AOL chat rooms in '99, and doing a bull raid on a stock? The short sellers have gotten incredibly crushed in all this, even before they ganged up on them.

Now they're ganging up on them. Who is left to buy when the buyer at the margin is somebody that's just trying to torture a short seller? So this is incredibly unhealthy. There will be hell to pay for what you're seeing on your screen right there.

JULIE HYMAN: Bill, it's Julie here. What is that going to look like, that hell to pay?

BILL SMEAD: Well, I'd go back and look at 2000 to 2003. What happened was, I think on March the 27th of 2000, Cisco reported earnings soared in value on that day to a $600 billion market capitalisation and then started in 85% or 90% decline over a 2 and 1/2 year time period. And that was a blue chip that survived and prospered.

The ones that weren't blue chips that survived and prospered, they went to Never Never Land, to Sun Microsystems Land, and GeoCities and those other places. So the beauty of it is, the abuse for this stuff is going to cause a whole generation of people to not want to participate in the stock market, which is exactly what happens every 30 years. We have to go through this.

JULIE HYMAN: Which is ironic, of course, because we've seen so many new participants get enthusiastically involved. GeoCities, isn't that a blast from the past, Bill? So OK, so let's take the other side of this then. What do you do in this environment to sort of avoid those potential kinds of blow ups? What kind of criteria are you considering right now? And where are you looking for sustainable value in this market?

BILL SMEAD: Well, the first thing you have to do is if there's going to be a hurricane in Miami, you can't be in Palm Beach. So even though we love some of our companies that we've held for a long time, if they've fallen into the growth category, which is where the speculative mania has a tendency to reside, you significantly reduce your positions.

The second thing you look at here is there's enormous financial stimulus being injected by the government. And the history of the government injecting massive stimulus relative to GDP like this and a large adult population group getting lodged in the 30 to 45-year-old age group, which is the age of necessity spending, the age of home buying, car buying, I owe, I owe, so off to work I go stage, you get inflation.

And inflation will be the subject matter that turns this market. When the market starts to discount significantly higher inflation, PE ratios contract, and interest rates rise. And that's when those wild speculative things will have all hell broke loose on.

BRIAN SOZZI: There you have the opening bell on Wall Street. The market looks to hopefully turn around, really, the action, the bad, the dour action of last week. Bill, who's to blame for the speculative mania we're now seeing in markets?

BILL SMEAD: That is a fantastic question. You go right to the head of the class. In the book, "A Short History of Financial Euphoria" by John Kenneth Galbraith, great book, 125 pages-- it's a three-hour read, brilliant wisdom-- it is completely and totally a normal function of markets. Financial euphoria episodes are supposed to happen. It's just the nature of markets. No one is to blame.

Now, if you get crushed by it, you are to blame for what you did to yourself. But no one is to blame for how economics works and how markets work. If President Biden significantly limits the ability to produce oil and gas, the price of oil and gas is likely to rise dramatically in the next three to five years. And that's the kind of thing that happens in an inflationary environment.

So again, there's ways to make money in here. Oil looks very attractive in here. You have to have something to make electricity with. So yes, that's kind of where we're heading.

MYLES UDLAND: And then, Bill, just finally, you mentioned energy as an area like. You also called out a couple of names, and we've talked about this, with coal earlier as well. The shift to suburbia is a theme that you guys are interested in as well. What do you like there?

BILL SMEAD: Well, we own the homebuilders. And there's 90 million millennials. They're just getting started buying houses. And it's funny. Investors are treating the homebuilders like we're way late in the cycle. Well, on a population adjusted basis, the current home building isn't even average. It's well below average on a population adjusted basis. So we like the homebuilders.

And then we also like the class A mall rates that are big in suburbia, right, because if everybody moves out of downtown, people that used to rent an apartment, they move an hour from downtown, then that's one of the things they're going to do, is they're going to be a lot closer to that property. And by the way, it's the property that has the value. It's not the shopping that has the value. It's the property that has the value.

MYLES UDLAND: All right, cycles in markets and cycles in life, millennials turning into their parents. All right, Bill Smead, Smead Capital Manager. Bill, always great to get your thoughts. Thanks so much for joining the show this morning.

BILL SMEAD: Thanks for having us.