Bearish investor sentiment usually has top investor Bill Smead ready to buy. Not this time.

• Bill Smead warns of further market downside.
• Smead cites high equity holdings and valuations as key concerns.
• He predicts a yearslong market adjustment, and is betting on energy stocks.

In prior market sell-offs, Bill Smead would be licking his chops right about now, getting ready to pounce on a discounted stock market that other investors had lost their appetites for.

But today, the value investor is not even peckish yet.

"The psychology of both the market and the economy are very bearish, and that would normally be a reason for us to be very positive," Smead, the founder of Smead Capital Management, told BI on Friday. "The problem is we have to unwind the largest mania of my career."

Smead started his career in 1980 trading for Drexel Burnham Lambert. He now manages the Smead Value Fund (SMVLX), which has beaten 96% of similar funds over the last 15 years, according to Morningstar data.

To illustrate how pessimistic investors have become amid President Donald Trump's tariff policies, Smead pointed to American Association of Individual Investors survey data showing that more than half of its members had been bearish for a record eight consecutive weeks. The most recent edition of Bank of America's Global Fund Manager Survey echoes the severity of this downbeat outlook in markets right now: the highest proportion of fund managers since 2000 plan to reduce exposure to stocks.

But with the market already having undergone a 19% pullback, why does Smead think the sell-off has further to run? He highlighted a couple of metrics that show historically high exposure to stocks.

One is household equity holdings as a percentage of household balance sheets. It was at record highs as of Q4 2024.

Second, the so-called Warren Buffett indicator of total stock-market capitalization relative to GDP is still near recent highs. The ratio would have to fall to around 80% to hit the same level when Buffett called a bottom in September 2009, he said. At its extreme lows in March 2009, the ratio fell to 51%.

This unwinding Smead expects will take a while to play out, he said.

"The market would have to fall 50%" to get to an 80% market cap-to-GDP ratio in the near term, he said. But "it probably won't get to that ratio in the short term. It will be a multiple-year phenomenon of getting to that ratio," he added.

Recent market volatility has cooled off as investors wait to see how tariffs impact both inflation and economic growth. Stagflation fears have grown, Bank of America's Global Fund Manager Survey shows, as tariffs threaten to hamper growth and raise consumer prices.

Smead has warned of a reckoning for the market over the last couple of years. Preparing for a shift out of highly valued tech stocks, he has loaded up on energy stocks, mall REITs, and homebuilders. That hurt him in 2024, when his fund rose only 3.5%. But he's betting a potential recession will be a boon for oil and gas stocks, typically a defensive sector that's now trading at cheap valuations after the trade war and production increases tanked prices.

"In the deep recession of '08, Americans used 2% less gas than the year before," he said.