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The Well-Known Fact Circa 2014 Presented by: Lead Portfolio Manager Bill Smead

The Well-Known Fact Circa 2014 Presented by: Lead Portfolio Manager Bill Smead. The Well-Known Fact Circa 2014. Today’s Agenda. Historical Well Known Facts Today's Well Known Facts Unknown Facts A Virtuous Response to The Well-Known Fact Circa 2014. The Well-Known Fact Circa 2014.

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The Well-Known Fact Circa 2014 Presented by: Lead Portfolio Manager Bill Smead

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  1. The Well-Known Fact Circa 2014 Presented by: Lead Portfolio Manager Bill Smead

  2. The Well-Known Fact Circa 2014 • Today’s Agenda • Historical Well Known Facts • Today's Well Known Facts • Unknown Facts • A Virtuous Response to The Well-Known Fact Circa 2014

  3. The Well-Known Fact Circa 2014 • SCM’s Definition • A “Well Known Fact” is defined as a body of economic information which is not only known throughout the economy and media, but has been acted upon by nearly all market participants. A “Well Known Fact” and its existence can serve as a contrary indicator in investment markets.

  4. The Well-Known Fact Circa 2014 • Symptoms and Environment • Media sounds the trumpet • Advisors adopt and promote • Historical positive bias (safe speculation) • Multi-year investment success well underway • Identifiable gurus and spokespersons • Loneliness for those not aligned with the Fact

  5. The Well-Known Fact Circa 2014 Tulip Mania of the Dutch Golden Age Attention came to be concentrated on the possession and display of the more esoteric of the blooms. And appreciation of the more exceptional of the flowers rapidly gave way to a yet deeper appreciation of the increase in the price that their beauty and rarity were commanding. By the mid 1630’s the increase seemed to be without limit. The rush to invest engulfed the whole of Holland. No person of minimal sensitivity of mind felt that he could be left behind. Prices were extravagant; by 1636, a bulb of no previous worth might be exchanged for “a new carriage, two grey horses and a complete harness (around $25,000 to $50,000 in today’s dollars). - John Kenneth Galbraith Source: A Short History of Financial Euphoria, John Kenneth Galbraith

  6. The Well-Known Fact Circa 2014 Tulip Mania of the Dutch Golden Age At last, however, the more prudent began to see that this folly could not last for ever. Rich people no longer bought the flowers to keep them in their gardens, but to sell them again at cent per cent profit. It was seen that somebody must lose fearfully in the end. As this conviction spread, prices fell, and never rose again. Confidence was destroyed, and a universal panic seized upon the dealers. - Charles MacKay Source: Preface to the 1952 Edition of Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Charles MacKay

  7. The Well-Known Fact Circa 2014 Historical Well Known Facts: Cars, Planes & Radio 1929

  8. The Well-Known Fact Circa 2014 The “Nifty Fifty”: One Decision Stocks Multiple Compression Security Price-Earnings Multiple Price-Earnings Multiple 1972 1980 Sony 92 17Polaroid 90 16McDonald’s 83 9Intl. Flavors 81 12Walt Disney 76 11Hewlett Packard 65 18 Source: Burton Gordon Malkiel, “A Random Walk Down Wall Street”, page 70

  9. The Well-Known Fact Circa 2014 The “Nifty Fifty”: One Decision Stocks • 1973-1974: The Nifty-Fifty Bubble Deflates The S&P 500 (Jan 11, 1973 – Oct 03, 1974) was down 48%. The Nifty Fifty fared much worse. Coca-Cola (KO) General Electric (GE) Avon (AVP) Disney (DIS) Past performance does not guarantee future results. Source: Bloomberg; Big Charts

  10. The Well-Known Fact Circa 2014 Oil, Gold and Bonds, early 1980’s Source: http://inflationdata.com/Inflation/images/charts/Oil/Gasoline_inflation_chart.htm

  11. The Well-Known Fact Circa 2014 Oil, Gold and Bonds, early 1980’s Source: http://inflationdata.com/articles/charts/inflation-adjusted-annual-average-gold-prices/

  12. The Well-Known Fact Circa 2014 Oil, Gold and Bonds, early 1980’s 10-Year Treasury Yields: Jan 1962 through April 2014 Source: Yahoo! Finance chart - CBOE Interest Rate 10-Year T-No (^TNX) from Jan 2, 1962 through Apr 1, 2014

  13. The Well-Known Fact Circa 2014 Japan and Japanese Stocks, late 1980’s Source: ThomsonReuters Baseline

  14. The Well-Known Fact Circa 2014 Japan and Japanese Stocks, late 1980’s “Tokyo land valuations had soared to the point where it was calculated that the site of the imperial palace, near the centre of the city, was worth more than all the real estate in California” -Telegraph UK Source (graphic) - “That’s Not How Bubbles Work” by www.huffingtonpost.com on July 20, 2009 Source (quote) - Telegraph UK “Oriental risks and rewards for optimistic occidentals” Aug 7, 2004

  15. The Well-Known Fact Circa 2014 Savings and Loan debacle 1987-1992 Source: thewealthsteward.com “U.S. bank failures lag economic & stock market bottoms” Aug 24, 2010

  16. The Well-Known Fact Circa 2014 Savings and Loan debacle 1989-1991 Source: Bloomberg

  17. The Well-Known Fact Circa 2014 “The Internet Will Change Your Life” / “New Economy” Source: Bloomberg

  18. The Well-Known Fact Circa 2014 Real-Estate / Credit Bubble 2003-2010 Source: Redfin Seattle Sweet Digs “Case-Shiller: Seasonal Home Price Bump Turns Flat in May” July 28, 2009

  19. The Well-Known Fact Circa 2014 • The Well-Known Fact Circa 2014 • Featured Stock: Bank of America • Historical Well Known Facts • Today's Well Known Facts • Unknown Facts • A Virtuous Response to The Well-Known Fact Circa 2014

  20. The Well-Known Fact Circa 2014 • “Once a price history develops, and people hear that their neighbor made a lot of money on something, that impulse takes over, and we're seeing that in commodities and housing...Orgies tend to be wildest toward the end. It's like being Cinderella at the ball. You know that at midnight everything's going to turn back to pumpkins & mice. But you look around and say, 'one more dance,' and so does everyone else. The party does get to be more fun -- and besides, there are no clocks on the wall. And then suddenly the clock strikes 12, and everything turns back to pumpkins and mice.” • - Warren Buffett Source: CNN Money article “Buffett: Real estate slowdown ahead” by Jason Zweig of May 8, 2006

  21. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact

  22. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Wide Diversification Note: alternative strategies include private equity (LBOs, mezzanine, M&A funds and international private equity); marketable alternatives (hedge funds, absolute return, market neutral, long/short, 130/30, event-driven and derivatives); venture capital; private equity real estate (non-campus); energy and natural resources (oil, gas, timber, commodities and managed futures); and distressed debt Past Performance does not Guarantee Future Returns Source: NACUBO-Commonfund public NCSE information

  23. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Lower Domestic Exposure Past Performance does not Guarantee Future Returns Source: http://www.top1000funds.com/news/2011/09/28/harvard-favours-emerging-markets-and-absolute-returns-over-fixed-income/

  24. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Emerging Markets a Must Own Past Performance does not Guarantee Future Returns Source: White Paper “Asset Allocation at Barclays”, March 2013, Page 14

  25. The Well-Known Fact Circa 2014 Today's Well Known Facts: Small-Caps Deserve Big Premiums! Source: Merrill Lynch “(Mid-) Year Ahead in Pictures”, page 92

  26. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Buy Hard-Assets Past Performance does not Guarantee Future Returns Source: Merrill Lynch report “Just in case rates don’t rise…”, chart 1 page 1

  27. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Oil Drilling Frenzy Past Performance does not Guarantee Future Returns Source: Fidelity Investments Institutional – Investment Themes for 2014, page 12

  28. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: The U.S. is Unattractive Source: http://video.cnbc.com/gallery/?video=3000099730

  29. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: The New Normal/Neutral Source: http://www.pewresearch.org/fact-tank/2013/10/18/millennials-still-lag-in-forming-their-own-households/

  30. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: Passive Investing Past Performance does not Guarantee Future Returns Source: 2014 Investment Company Fact Book

  31. The Well-Known Fact Circa 2014 • Today’s Well-Known Fact: ETF Panacea Past Performance does not Guarantee Future Returns Source: 2014 Investment Company Fact Book

  32. The Well-Known Fact Circa 2014 • The Well-Known Fact Circa 2014 • Featured Stock: Bank of America • Historical Well Known Facts • Today's Well Known Facts • Unknown Facts • A Virtuous Response to The Well-Known Fact Circa 2014

  33. The Well-Known Fact Circa 2014 • Keynes on Well-Known Facts • “It [investing] is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find any one agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is the right moment for selling it.” • - John Maynard Keynes Source: http://www.maynardkeynes.org/keynes-the-investor.html

  34. The Well-Known Fact Circa 2014 Unknown Facts: U.S. Households are in Great Shape % (Percent) Federal Reserve US Financial Obligations Ratio - An estimate of the ratio of debt payments to disposable income. The types of debt included in the financial obligation ratio include mortgage payments, credit cards, property tax and lease payments. Source: Bloomberg

  35. The Well-Known Fact Circa 2014 Unknown Facts: New Era of Regulation and Litigation for Banks Source: WSJ article “BofA in Talks to Pay At Least $12 Billion to Settle Probes”, June 5, 2014

  36. The Well-Known Fact Circa 2014 Unknown Facts: U.S. Banks at Historically Low Stress Levels St Louis Fed Financial Stress Index (Ticker: STLFSI / SLF FSI): • This Index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Values below zero suggest below-average financial market stress, while values above zero suggest above-average financial market stress. Past performance does not guarantee future results. Source: Bloomberg

  37. The Well-Known Fact Circa 2014 Unknown Facts: Housing is Very Affordable • To interpret the indices, a value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment. Source: Bloomberg

  38. The Well-Known Fact Circa 2014 Unknown Facts: Housing Starts/Supply Coming Off Record Lows Number of new housing units started in the U.S., annually, In Thousands Source: Bloomberg

  39. The Well-Known Fact Circa 2014 Unknown Facts: Housing has Leverage to the Economy • Residential fixed investment includes the construction of new single-family and multi-family houses, manufactured housing (or mobile homes) and home improvements.  Also included in residential fixed investment are the brokers’ commissions on sales, net purchases of used structures and residential equipment. Source: http://www.bespokeinvest.com/thinkbig/2014/4/23/housing-and-economic-growth.html

  40. The Well-Known Fact Circa 2014 Unknown Facts: Low Interest Rates Likely to Rise Slowly Source: http://online.barrons.com/news/articles/SB50001424053111903409104579517663810941986

  41. The Well-Known Fact Circa 2014 Unknown Facts: Gorgeous Demographics • Developed economies are about to experience a baby boom that will be bigger and longer-lasting than even the one that followed the Second World War. • The entry of the Millennial generation into their prime childbearing years, along with the recouping of births that were postponed both due to the recession and by the decision of many women to delay having children until their thirties, will drive the first leg of this new baby boom • Continued progress in creating more family-friendly labor market institutions in developed economies, increased gender equality, rising incomes, as well as cultural and possibly genetically-driven shifts in the composition of populations towards more fecund individuals will all power the second leg of the baby boom. • Faster population growth implies stronger aggregate demand in the near term and more rapid supply growth over the long haul. Equities, housing, and commodities should benefit. • Properly measured, U.S. fertility rates are already well above the baseline used by the government in projecting future fiscal trends. Our estimates imply a fiscal surplus of 4% of GDP by the end of the century, even if current entitlement programs are not scaled back. - The Bank Credit Analyst, September 2013 Source: The Bank Credit Analyst, September 2013 “The Coming Baby Boom in Developed Economies”

  42. The Well-Known Fact Circa 2014 • Unknown Facts: Underinvested & Risk-Averse Source: MarketWatch / Howard Gold article “Not even a bull market can interest people in stocks”, June 8, 2014

  43. The Well-Known Fact Circa 2014 • Unknown Facts: Underinvested & Risk-Averse Source: http://mjperry.blogspot.com/2012/04/2011-most-energy-efficient-economy-in.html

  44. The Well-Known Fact Circa 2014 • The Well-Known Fact Circa 2014 • Featured Stock: Bank of America • Historical Well Known Facts • Today's Well Known Facts • Unknown Facts • A Virtuous Response to The Well-Known Fact Circa 2014

  45. The Well-Known Fact Circa 2014 • A Virtuous Response to The Well-Known Fact • Flee the Area • Buy what is undervalued because of the massive capital misallocation • Show immense patience

  46. The Well-Known Fact Circa 2014 A Virtuous Response: Flee The Area Data going back to 1795, with first data point 12/31/1805 – through April 2, 2014 Source: Commodities 1795 to 1890 are the Warren & Pearson index constructed with farm products, foods, hides & leather, textiles, fuel & lighting, metals & metal products, building materials, chemicals & drugs, household furnishing goods, spirits and other commodities. 1891 to 1913 is the Wholesale Commodities Price Index from the BLS and other agencies. 1914 to 1956 is the PPI for All Commodities, and 1957 to present is the CRB CCI Index. Past Performance is not a guarantee of future results Source: StifelNicolaus / Barry Bannister April 2, 2014

  47. The Well-Known Fact Circa 2014 A Virtuous Response: Buy Into Capitulation and Fear Source: Bloomberg

  48. The Well-Known Fact Circa 2014 A Virtuous Response: Flee The Area • MSCI EM (Ticker MXEF) Index: The Morgan Stanley Capital Emerging Markets Index is a free float weighted equity index. • MSCI EAFE (Ticker MXEA) Index: The MSCI EAFE Index is a free-float weighted equity index. The index was developed with a base value of 100 as of December 31 1969. The MSCI EAFE region covers DM countries in Europe, Australasia, Israel, and the Far East. • S&P 500 (Ticker SPX) Index: Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941- 43 base period. Source: Bloomberg

  49. The Well-Known Fact Circa 2014 A Virtuous Response: Recognize Capital Misallocation Source: http://online.wsj.com/news/articles/SB10001424052702304819004579489033376330174

  50. The Well-Known Fact Circa 2014 A Virtuous Response: Recognize Capital Misallocation Source: http://online.wsj.com/news/article_email/private-equity-has-more-than-it-can-spend-1402670650-lMyQjAxMTA0MDEwODExNDgyWj

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