Dear fellow investors,
Over the weekend I stopped to watch the last part of a James Stewart Western called, The Far Country. It was the story of two cattle drivers who took their cattle all the way to the Yukon to get a piece of the late 1890’s Klondike gold rush. Like many of these movies and many gold rushes, it ended with Jimmy shooting the bad guys after the prospecting did not work out well for late arrivals to the Yukon.
We are writing you from Seattle — known as the “Gateway to Alaska,” which is where gold miners got their supplies and found passage on steamships to Alaska. For example, Nordstrom’s shoe store in downtown Seattle realized its first big success selling boots to miners passing through town to Alaska. It is our opinion that we Seattleites are in another rush, but this time it is a technology rush and Amazon is at the heart of it.
According to The Seattle Times article “Amazon’s hiring frenzy slows sharply; what’s going on?”:
On July 17 [2017], a Monday – the day of the week when new hires arrive on Amazon’s South Lake Union campus – Amazon set a new high-water mark. That day, the company welcomed 767 new employees. That’s more than most local employers hire in a year.
Year-over-year in September, Amazon’s corporate employment grew 77% to 541,000.1 Amazon’s footprint in Seattle is more than twice the size of the corporate imprint of any major city in America. Seattle has approximately 700,000 residents and King County has around 2,200,000. King County will have issued close to 280,000 new driver’s licenses in the four years ending in 2017! It’s as if we’re mining Bitcoin here.
In addition, for two consecutive years Seattle has had the largest number of building cranes in operation of any city in the U.S. despite being only the 15th largest city in America. Those cranes are called booms and their huge numbers in Seattle automatically describe us as a “boom” town.
We believe we are close-up witnesses to the heart of this gold-rush-like bubble in technology enthusiasm. A massive victory party in the U.S. stock market has been occurring due to the success of e-commerce and cloud computing services. Amazon is the premier company in both cloud services and the largest e-commerce company in America! It is almost impossible to visualize what could get in the way of the tech rush in Amazon’s fortunes, even though the stock trades at an extremely high P/E ratio. However, the fact that it has created an unsustainable boom and makes Seattle its ground zero, forces us to consider more far-reaching consequences.
Therefore, what can we rely on which would tell us that the bad guys need to be shot and late arrivals are going to end up without finding the tech riches? The answers lay in the history of the investment markets and the importance of psychology at stock market extremes.
History
As a 37-year veteran of the investment business, there is only one guarantee: things are going to change. When railroads were the rage, booms and busts in the U.S. economy were closely tied to the rush attached to them. In 1862, President Lincoln signed legislation which funded the building of an “overland route” to the west coast which started in Council Bluffs, Iowa. The Union Pacific Rail Road was born and eventually was merged with the Union Pacific Railway. It declared bankruptcy in the Panic of 1893.
Bustling excitement in the new technology surrounded automobiles and air flight, and the development of the radio business created a U.S. boom in the 1920s. RCA was the maker of radios, the owner of a major radio broadcasting company and the producer of a great deal of the content broadcast on the radio. RCA’s boom was centered in New York City because NYC was the hub of the entertainment industry at that time. The crash of 1929 and the depression which followed caused both good guys and bad guys to lose on that euphoric bubble.
In past missives, we have reviewed the Nifty-Fifty mania of the early 1970s, the mania for inflation hedges in the late 1970’s, the tech bubble centered in Silicon Valley in the late 1990s and the residential real estate bubble of the mid-2000s. All recorded history argues that Warren Buffett is correct about exciting rushes in investment markets. He says that euphoric bubbles are like Cinderella at the ball, “the clock eventually strikes midnight and everything turns to pumpkins and mice!” History would argue that Seattle is late in its tech rush and since Amazon is at the heart of Seattle’s financial euphoria, investors should be highly cautious.
Psychology
At stock market extremes, there is uniform bullishness or bearishness among professional investors. Recently, the Investors Intelligence survey of newsletter writers had its second highest reading in 30 years with 64% bulls and 15% bears. We believe their bullishness is tied closely to the tech rush in force.
The FAANG stocks (Facebook, Amazon, Apple, Netflix and Google parent Alphabet) have led the way by pasting the other stocks in the S&P 500 for two consecutive years.2 Historical statistics show that value outperforms growth over long stretches of time, but growth stocks, led by Amazon, have smoked their value brethren the way the local sheriff thwarted the good guys in the Jimmy Stewart movie, The Far Country.
On Amazon, the Wall Street research community has 92% of its analysts with buy ratings out of 50 total analysts. Despite the shrunken number of research firms on Wall Street, having 50 research analysts is a huge number. Walmart and Oracle both have 36 analysts following them, as an example.3
The ultimate psychological indicators in a gold rush in technology are the homes and headquarters buildings built during the boom. Amazon opened its biosphere headquarters this year and is very anxious to create another one in a city which is yet to be named. The Empire State Building, Bill Gate’s Lake Washington home and Devon Energy’s headquarters correctly punctuated prior gold rush environments in 1929, 1999 and oil in 2008. Will this time be any different?
Unfortunately for our readers, we have no ability to time these phenomena. Buffett says, “Our job is to decide whether, the market’s job is to decide when.” We are willing to stand up at this point and argue that what is left to gain from the current mania continuing is not worthwhile in relation to the risk investors are taking both in Seattle’s commercial property market and in Amazon’s stock. We can’t be visualizing what would ruin the run this amazing company has had, but history would argue that those late to a rush come out injured on a stock or owing somebody money on a loan.
Warm regards,
William Smead
Chief Executive Officer
Chief Investment Officer
1Source: Bloomberg
2Source: Stifel Market Strategy report, June 1, 2017
3 Source: Bloomberg
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 and CEO, 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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