Bill Smead makes a living identifying long-term investment trends. As co-manager of the Smead Value Fund (SMVLX), he’s outperformed 98% of comparable funds over the past 15 years, delivering an average annual return of 15% to investors since July 2009, according to Morningstar.
That’s why Smead’s latest note to investors may be hard to swallow.
Smead doesn’t like the long-term outlook for major stock indexes like the S&P 500 and Nasdaq 100. Though those indexes have recovered recently and are hitting new highs, he said there are some warning signs that the overall market could underperform going forward.
First, short interest (stocks borrowed by investors in anticipation of a stock’s fall) is extremely low on the S&P 500 and Nasdaq 100, suggesting investors may be too bullish. Investor sentiment has historically acted as a contrarian indicator of future performance. For example, Bank of America’s Bull/Bear indicator emits buy signals when sentiment is bad and sell signals when sentiment is bullish.
Smead Capital Management
Second, household allocations to equities remain at record levels, with 42% of household wealth invested in equities — another sign of extremely bullish sentiment. The only other times allocations to equities have been this high were during the early stages of the recovery from the pandemic and near the peak of the dot-com bubble leading up to 2000.
Smead Capital Management
Looking at current equity allocation levels, we also see that the S&P 500 is likely to deliver negative returns over the next decade.
“High holdings portend weaker index performance,” Smead said in a note.
Relatedly, recent Bank of America data shows that allocations to cash by fund managers are at an all-time low, another sign that investors are confident they can get better returns elsewhere, which is even more surprising given the robust, risk-free returns that cash offers.
Smead Capital Management
“We are contrarians and, strangely enough, we wait for the moment when history, psychology and mathematics are overturned in the U.S. stock market,” Smead said. “We believe that moment is now.”
While much of Wall Street remains bullish in the short term, Smead is not alone in his skepticism about the market’s ability to continue delivering strong gains over the long term.
Rob Arnott, founder of Research Affiliates, said there are many subsectors and markets around the world that offer better return prospects than indexes like the S&P 500, including international value stocks, REITs, small caps and stocks from developed markets outside the U.S.
“I’ve been called a perpetual bear, but I’m not. I’m bullish on cheap stuff,” Arnott told Business Insider in May. “I’m not bearish on stuff that’s priced to give me double-digit returns, and there’s a lot of that out there right now.”
GMO co-founder Jeremy Grantham warned that the S&P 500 index is set to fall sharply in the coming days due to inflated valuations, saying he favors quality and deep value drivers.
For Smead, the best returns are likely to come from oil and homebuilding stocks, both of which are trading at a “50% discount.”
As for oil stocks, he believes analysts are underestimating earnings with crude prices hovering above $80 a barrel, while homebuilding stocks are seeing investor optimism stagnate as interest rates remain high.
Investors can gain exposure to these sectors through funds such as Invesco DB Oil Fund (DBO) and iShares US Home Construction ETF (ITB).
