Stocks just hit a 'line of death' last reached at the peak of the dot-com bubble, veteran investor Bill Smead warns
Bill Smead doesn't know how long the current stock-market rally can continue, but the veteran investor does think it's in a particularly vulnerable spot.
In his Q2 letter to investors on July 15, Smead — whose Smead Value Fund (SMVLX) has beaten 96% of peers over the last 15 years, Morningstar data shows — shared a chart displaying inflation-adjusted S&P 500 returns since the 1960s.
An upward trend line shows resistance at two major market peaks, in 1966 and in 2000, is also shown. In both of those instances when S&P 500 inflation-adjusted returns hit the trend line, a significant correction followed.
In recent weeks, the market has touched the line for the third time since 1960 as the S&P 500 has surged to all-time highs around 6,300.
There's no rule that says the market's rally can't break higher, especially if economic fundamentals, like inflation, consumer spending, and the unemployment rate, remain solid. But to be sure, it's a foreboding reminder about how frothy the current environment is, and Smead thinks the market is set up for disaster where the S&P 500 delivers exceptionally poor returns over the decade ahead.
"That doesn't tell you when, but it does tell you a lot about the magnitude and the duration of what's going to happen," Smead told Business Insider.
"You can't hold your breath until it breaks," he continued. "It's not a question of whether, it's a question of when."
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The market's impressive returns recently have been driven by growth stocks, particularly the Magnificent Seven mega-cap tech companies. So it's not necessarily surprising that Smead, a value investor, is bearish on growth stocks' prospects.
A shift toward value outperformance would benefit Smead's fund, which is down 10.6% over the last 12 months. The Smead Value Fund's holdings are most heavily concentrated in the energy, consumer cyclical, and financials sectors.
Still, Smead's impressive long-term track record shows he could be onto something. Other popular measures of investor euphoria also show the market is at historically rich levels. For example, the Shiller cyclically-adjusted price-to-earnings ratio is near all-time highs.
Smead also cited Warren Buffett's seemingly cautious approach in recent years, holding a record cash position, as a warning sign that things could go awry in the market. Buffett warned of froth in the market leading up to the dot-com bubble, leading him to take a more conservative stance in his portfolio. As a result, his performance suffered in the year leading up to the bubble's peak, but Buffett later smashed the S&P 500's returns when the market crashed over the course of a few years.
"Everybody wants to know why Warren Buffett holds so much cash," Smead said. "It's because he knows that at some point here this thing is going to get slaughtered."
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