As contrarian investors and students of group-think crowd psychology, we look for investment opportunities in the way news is framed. There is an old Mark Twain saying, “Lies, damned lies and statistics.” We believe investors are getting mislead by statistics surrounding the U.S. economy and we will seek to dispel erroneous assumptions in search of long-term gains in the stock market.
The Middle Class
A recent CNBC website article reported an interesting statistic. It explained that 70% of Americans believe they are part of the middle class.1 Pew research indicates that family income levels show that 50% of the population is middle class, down from 61% in 1970. How does the media frame this information?
First, the nationwide income levels don’t take into consideration where in the U.S. people live. An upper-class income in an expensive coastal city could result in a much lower-quality lifestyle than the same income does nationwide. An income at the top of the lower class in an extremely inexpensive area could throw off a middle class living style. Also, some people with higher incomes and higher savings rates live way inside their means, a spending pattern similar to those in the middle class. Hence, the mental classification.
Second, the media and political class have viewed the loss of 11% of the families out of the middle class as an indictment of our democratic capitalist economic system. What they fail to mention is that 7% of the 11% went to upper class and 4% were added to lower class. We are in the camp which abhors anyone being left out, but this shouldn't be framed as a negative overall.
The U.S. Birth Rate
In a surprise to demographers, total U.S. births have been flat for two years, despite a significant increase in birth rates among women 30-45 years of age. The framers of news are starting to question if our national birth rate will ever break away from the patterns of other industrialized nations like a Germany, France and Japan, whose rates are way below the replacement level needed to maintain population. The crowd is bearish on household formation and industries affected by the statistics.
The truth is we have seen births of women under 25 years of age fall off a cliff in the last 25 years. In other words, the U.S. has gone from birthing children into homes which can least afford them to birthing them into above-average income homes of people 30-45 years of age. These are men and women much deeper into their career path. It means the spending on kids should explode as the largest population group moves firmly into their 30s. It also means first-time and second-time home buyers are purchasing much nicer homes than prior generations.
Mortgage Rates, Home Prices and Affordability
There is a spectacular outpouring of news lately which frames a housing slowdown nationwide because of a pullback in the most expensive coastal cities like New York and Seattle. This framing proposes that mortgage interest rates of 4.6% and the average nationwide price of $302,000 for a newly-built home will lead to a cyclical downturn in the publicly-traded home builders.
The truth is that demographic demand from 30-45 year-old Americans, shown in the chart above, could overwhelm price and interest rates as a primary factor.2 The lowest interest rates and most affordable homes were in 2011 and we built a paltry 320,000 homes. One of the least affordable years since 1960 was 1978. Prices had risen sharply, interest rates were 12% and we built 1.4 million homes! Why did that happen? The largest population group before the Millennials, the baby boomers, were having kids and buying houses. They wisely defended themselves from future higher rents and built up net worth through the forced saving provided by paying off a mortgage.
Velocity of Money and the Multiplier Effect
The future of the U.S. economy is being framed by the media. They argue that the length of the recovery should put us on high alert for a recession. Far more important to economic vitality is the velocity of money and the multiplier effect created by the economic activity we have. The Fed poured money into the system from 2009 to 2015 and helped us crawl out of the deepest recession since the depression. There was no pick-up in the velocity of money.3
We healed, but we were growing at historically anemic rates. What sends velocity higher? Many other market participants are affected when velocity picks up as the largest population group buys houses, furnishes them, landscapes them, paints and carpets them.
Think of it like this. The last ten years our economy grew on purchases at fast-food establishments, craft beer vendors and from buyers of new Apple devices. The problem is the workers at the establishments, vendors, and those who put Apple devices together either couldn’t afford a house or live in another country. Therefore, the velocity of money was held down and the normal multiplier effect we learned in macroeconomics never started happening until home building picked up. We have not seen this discussion in the media.
Investment Ramifications of News Framing
We are bottom-up stock pickers and utilize our eight criteria for stock selection. We are finding numerous opportunities to buy companies which would be positively impacted by a pickup in the velocity of money and from the multiplier effect getting kicked into gear. We like NVR (NVR), the nation’s fifth largest home builder, even though we are sitting through a temporary lull in home buying. We also see a bright future for our bank stocks, which benefit from a rise in the velocity of money and better interest spreads as economic growth causes rates to rise.
We like a series of companies which cater to 30-45 year-old families with kids. Disney (DIS) is getting ready for a big increase in the number of five to ten-year old children since there are 26 million more millennial Americans than there were Gen Xers. Disney owns the market for wholesome family entertainment right before the number of wholesome homes explodes. Discovery Inc. (DISCA) has HGTV, Deadliest Catch and many of the favorite unscripted TV shows watched by 30-45 year-old families. Target (TGT) is a favorite place and website to shop for above-average income folks. They go in to get three essentials and leave with three things they never planned on buying. The profit is in those unplanned purchases.
In conclusion, we don’t have any hard feelings about the way news is framed. The writer provides the information and frames it in the way that makes the most sense to them. Our job is to dig into the numbers and use the information to gain an advantage in long-duration stock picking. After all, we like the high probability that people will grow older and behavior will be changed to conform with the next stage of life. Like Wayne Gretsky said, “Skate to where the puck is going to be.”
2Source: Bank of America Merrill Lynch
The information contained in this missive represents Smead Capital Management's opinions and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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