A top 1% fund manager for the past 15 years warns a selling spiral threatens to sink the market — and shares 4 stocks he’s betting on to capitalize on the turmoil

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• Bill Smead warns of major stock market bubble, predicting poor long-term performance of the S&P 500.
• Smead cites high stock holdings in household portfolios and high valuation measures.
• He suggests investing in homebuilders and oil stocks to capitalize on a falling rate environment.

Bill Smead doesn’t like the current market situation.

Sure, the S&P 500 just hit a new all-time high after rising 36% from October to July. Sure, earnings growth is solid. But Smead is skeptical that this run of strength will last.

In an interview with Business Insider on Wednesday, Smead said we are in one of the biggest bubbles in market history.

“We view this as the fourth great financial euphoria of the last 100 years: 1929, 1969, 1999 and now,” said Smead, who manages the Smead Value Fund (SMVLX). The fund has outperformed 99% of similar funds over the past 10 and 15 years, according to Morningstar data.

There are plenty of data points to support Smead’s forecast. One he cited in an Aug. 6 note: the percentage of stocks held in household portfolios. Right now, it’s at an all-time high.

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Let’s take for example two famous evaluation measures.

The Shiller cyclically adjusted price-to-earnings ratio, which is a 10-year moving average of stock market valuations, is above 1929 levels and only reaches its 2021 and 1999 peaks.

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And the Warren Buffett indicator, or total market capitalization relative to GDP, is hovering just below its all-time highs.

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The broad nature of today’s market allows Smead to be certain of one thing: The S&P 500 will underperform over the next decade or more. While valuations are poor indicators of short-term market performance, they tend to be the most important factor in determining long-term stock performance. According to a Bank of America analysis, 80% of the market’s performance over a 10-year period can be attributed to initial valuations.

“We are absolutely convinced that people are not going to make money in the next 10 to 15 years on the S&P 500 index, except for trading purposes,” Smead said.

“History proves it,” he continued. “Between 1964 and 1971, the Dow Jones didn’t make any money. And between 1999 and 2009, the S&P 500 didn’t make any money.”

But Smead also turned pessimistic about the market’s near-term outlook, largely due to the weight of technology stocks in the index. With weak recent earnings in the technology sector, the sector has suffered its worst run since 2022. From June 10 to August 7, the Technology Select Sector SPDR (XLK) Fund fell 17%.

Given the sector’s 31% weight in the S&P 500, Smead believes its poor performance will continue to drag the index down, causing more investors to sell the index, further hurting tech stocks, and so on.

“Selling begets more selling and feeds on itself. Major stock prices start to underperform, which drives down the S&P 500, which in turn drives down the index. The index selling weighs on larger-cap stocks, which adds additional legs to the index selling.”

Moreover, inflation is “well-anchored” in the economy, he believes, and once the Fed starts lowering interest rates to avoid a recession, prices will start rising faster again. That will hurt the market’s valuation, which currently stands at 21 times earnings, well above its long-term average of 14 times.

The stocks Smead is banking on

Smead’s views align him with ultra-bearish fund managers like Jeremy Grantham and John Hussman, both of whom believe stocks are in a bubble and will deliver poor long-term returns.

While Smead could be proven right over the next decade or more (a time frame to which his track record lends credibility), it’s hard to say whether his near-term skepticism about the market will play out. The S&P 500 is up 49% since late 2022 as bears continue to warn of a decline.

Stocks suffered a sustained selloff for a few days earlier this month as the July jobs report came in worse than expected, raising questions about the health of the economy. But the market has rebounded in recent days, and investors will be waiting for more data to confirm whether the labor market deterioration is substantial or not.

If stocks continue to fall, Smead has a few ideas for capitalizing on the decline. First, he likes homebuilders, which he believes will benefit from lower mortgage rates as the Fed prepares to cut its overnight lending rate for the first time since its aggressive hiking cycle began in 2022.

Two in particular that Smead is betting on are DR Horton (DHI) And Lennar (LEN).

Second, lower interest rates would boost demand and could cause a resurgence in inflation, which would be good for oil stocks, Smead said. He has positions in Occidental Petroleum (OXY) And Apache (APA).