Common stock investors are looking at an economic recovery in the U.S., which has not been interrupted by recession since 2009, and a stock market advance with temporary declines only in 2010, 2011 and in the summer this year. Since the declines in price have been something less than 20%, market participants assume that both the economic expansion and the bull market in U.S. stocks are “long in the tooth.”

We at Smead Capital Management believe that the classic Carpenters’ song “We’ve Only Just Begun,” from the 1970s tells the story of where we are headed over the next five to ten years in the U.S.

We’ve only just begun to live
White lace and promises
A kiss for luck and we’re on our way
(We’ve only begun)

We argue that the U.S. economy and stock market have “only just begun to live.” The “white lace” in the economy comes from the importance of household formation and home building. From the chart below, you can see that the current single-family housing starts would be among the worst recession number of the 1950s, 1960s and 1970s, when the population was 40-60% of what it is today. The largest adult population group in the U.S. (23-33 years of age) has seen only 25% of their group start the home buying process.

Millennials, as these folks are dubbed by the media, have a great deal of “promise” in household formation even if a substantial number of them are different culturally than past generations. The two main reasons that household formation has been slow in America over the last 6 years were the financial meltdown and the fact that the average age of marriage has risen to over 28 from 23 in 1981.

These young Americans have a “kiss for luck.” Housing is the most affordable “kiss” for young married couples in my lifetime. Household income statements are the cleanest in 35 years and unemployment rates are low enough to begin to draw folks off of the sideline, who had quit looking for work. Home builders employ a great deal of unskilled labor and the businesses who gain the multiplier effect from local building activity also employ unskilled labor. Think lumber, bricks, paint, etc. Time is the only thing needed for this to go “on [their] way” in the U.S.

Before the risin’ sun, we fly
So many roads to choose
We’ll start out walkin’ and learn to run
And yes we’ve just begun

Investors are frustrated by too many “roads to choose.” Wide asset allocation has sent institutional and high net worth individual investors away from U.S. common stocks since 2003. Second, investors all “start out walkin and learn to run.” Legendary investor, Bill Miller, said on CNBC in late October, “Despite the fact that we have moderate growth in the economy and low inflation, people hate stocks!” Impatience is killing investment success because most investors don’t trust the U.S. stock market in the aftermath of two huge bear markets in the last 15 years.

And when the evening comes, we smile
So much of life ahead
We’ll find a place where there’s room to grow
And yes, we’ve just begun

The United States is a place where “there’s room to grow” in the economy and the stock market. Our portfolio focuses on three areas where future growth is attractive and stock prices are available on a contentious basis (valuation matters dearly). First, we believe home building should grow immensely. We have companies like NVR (NVR), Berkshire Hathaway (BRK.B) and Home Depot (HD) involved directly in housing. Mortgage lending and credit creation could boom as young adults have “so much of life ahead.” We like the major banks (JPM, WFC and BAC) and financial service entities which would prosper from an improvement in the velocity of money.

Second, we suspect overall prosperity will improve and like to own shares of companies which have addicted customer bases to grow because new households have “only just begun.” This includes media companies like Disney (DIS), Tegna (TGNA), Comcast (CMCSK) and Gannett (GCI), which will provide content much more valuable to families than to single Americans. It also includes PayPal (PYPL), eBay (EBAY), Nordstrom (JWN) and Cabela’s (CAB), which will facilitate commerce and provide the goods demanded by a more prosperous era.

Third, we want to share the seemingly unlimited “horizons” offered to the medicine and vaccine makers in the U.S. We like Amgen (AMGN), Gilead Sciences (GILD) and Merck (MRK), among others in that sector of the stock market. My population group, baby boomers, will absorb a great deal of medicine the next 30 years as we live long lives with chronic illnesses. All these things could come true if, as Karen Carpenter sang, “We’ve only just begun.”

Warm Regards,
William Smead

The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

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