Will Millennials Drive in 2-0-1-5?Learn more about this firm
They Are Here
It is our opinion that the most important question in stock picking is one related to the Millennial group. Will they drive the U.S. Economy in 2015 through 2020 and in the process greatly impact the long-term profitability of the businesses which benefit the most from their emergence?
Luckily, we at Smead Capital Management run a “laboratory” for this sort of thing. As the employer of six echo-boomers, the father of five echo-boomers and three echo-boomer children-in-law, I suspect we have a reasonable lens with which we can view the economic behavior of the largest population group in America.
Here is a snapshot of the landscape: the U.S. has around 86 million people lodged between 19 to 37 years old. This group has different living patterns than prior generations, but probably holds the key to faster economic growth rates for U.S. GDP. They marry later in life than prior groups (28 years old on average) and both spouses come into marriage with a career (on average). Many have student debt leftover from college, but have better balance sheets than prior generations. This is because a much smaller percentage of them are buying a home and haven't yet taken on mortgage debt. Lastly, echo-boomers economic behavior has been heavily influenced by the financial meltdown of 2007-09, high unemployment rates and $4.00 per gallon gasoline for much of the last four years.
If they are to drive in 2-0-1-5, they must replicate—albeit at an older age— some of the basic economic behavior of all previous generations. First, they must marry and form households. Second, they must have children. Third, they must get an automobile which fits two adults, a car seat and the junk they carry with them. Fourth, they must want to get the privacy only associated with a stand-alone home.
Household formation has been low for the last five years. First-time home buying has been negligent. Single-family housing starts, adjusted for population have been in a depression since 2007. The average car on the road is 11 years old.
The combination of the factors listed above has created immense affordability in buying homes versus renting. As recently reported, American households spend a record 30% of their gross income on rent. They only have to spend 15% of gross income to buy a house, way under the long-term average of 22%. These numbers scream “buy!” Here is how Warren Buffett describes the situation a few months back at a Fortune magazine conference in Laguna Niguel, California:
You would think that people would be lining up now to get mortgages to buy a home. It’s a good way to go short the dollar, short interest rates. It is a no-brainer…Household formation falls off dramatically in a recession, at least initially, but that doesn’t last long. Hormones kick in and in-laws get tiresome, too.
Housing is the most affordable in my lifetime. Interest rates are the lowest since the early 1960's. Gasoline is approaching $2.50 per gallon nationwide. Just about every favorable factor is being tossed at these echo-boomers. As of the end of 2014, they have yet to break out and take the risks that all prior generations have taken.
However, if echo-boomers stay single, living in urban apartments and glued to technology devices, the fascination with cutting edge tech might be justified. It also explains why the largest investors in the world under-own domestically-oriented large-cap U.S. common stocks compared to the last 25 years.
Echo-boomer economic maturity is behind "new normal" 2% GDP growth expectations. It helps explain the extremely low interest rates for fixed income investments. It explains the popularity of exciting and relatively-new technology companies which seem to grow fast in a difficult and risk adverse economic climate.
So, why do Millennial life events matter to us as long-duration stock pickers? We suspect, like Buffett, that hormones will kick-in. But it seems that the best minds in the investment world still doubt that Millennials will drive American economic leadership and thus our view of their role in leading the economy remains very contentious.
How They’ll Get Where They’re Going
In his book, Great by Choice, Jim Collins explains how great companies make the best of both lousy and good luck. Because every company faces both in long-duration holding periods, we want to find high-quality companies that can make the best.
We have enjoyed the last five years in the U.S. stock market, as companies which meet our eight criteria for stock selection proved that they can make the best of lousy economic conditions. This brings us to the contentious nature of our confidence in holding the same companies. We want to see how they do in good economic conditions, as some very good mean reverting circumstances set up to invigorate the earnings growth and intrinsic value of our companies!
What is out there in the economic world to revert? First, the majority of echo-boomers will marry and have children. As BCA Research tells us, they are likely to have the majority of their kids in their thirties and we are seeing this around us anecdotally from our in-house Millennials and their friends. BCA looks for a baby boom in the developed world and since the prediction is logical, mathematical and contentious, we like it.
Second, buying a home won't stay monumentally cheaper than renting for much longer. Echo-boomers will listen to their screaming six-month old baby and conclude that commuting is part of real life or that working remotely makes life much better. Once their peers get rolling, monkeys will see and monkeys will do. Nearly everyone wants a yard for their child. Once this happens, echo-boomers will become an economic-multiplying entity and a member of a smaller and more identifiable community.
Third, leadership in consumer spending, triggered by mounting household formation will stimulate the other age groups to have confidence. The Federal Reserve Board has computed the household debt service ratio for 35 years. It is at 35-year lows and could cause 4% or greater non-inflationary GDP growth for years by just revering to 35-year averages. All age groups have been mega gun shy, including baby-boomers. You can't take future consumption with you when you die!
Lastly, for other than the largest cities like New York and San Francisco, lower gasoline should be a huge stimulus to commuters and motivator to recently married couples buying a house. Milton Friedman taught us about the difference between transitory income and regular income. Two months of cheaper gasoline is transitory, but if it stays down for six to twelve months echo-boomers and other Americans will put it in their budgets.
Going There With Them
Where does this take us in long-duration common stock investing? For us, the answer is to stay put in the consumer discretionary, domestically-oriented companies which are most affected by higher GDP growth rates and more normal consumer behavior.
Does the bull market in home building and mortgage origination end before the houses start getting built? Do you avoid the premier retail entities like Nordstrom (JWN) and Cabela's (CAB) before consumption mean reverts and average family wages jump due to better economic times? Do you listen to the tech-addicted media, who think that Netflix kills Comcast (CMCSK) and YouTube kills network-affiliated TV from Gannett (GCI)? Married couples with toddlers voluntarily stay at home in the evenings and absorb massive amounts of TV advertising while using high-speed access online.
Bernard Baruch was asked what behavior made him the most money in the stock market. His answer: "Sitting on my hands." We are very comfortable with our portfolio of stocks and are happy to keep the turnover expense at a minimum. We are very grateful to all our clients for your confidence and trust as we enter 2015.