A top-1% fund manager warns Warren Buffett is behaving like he did before the dot-com crash — and says the S&P 500 could see dismal returns for a decade

Smead has brilliantly executed the investing philosophy managing the Smead Value Fund (SMVLX), beating 99% of similar funds over the last 15 years, according to Morningstar data. He’s also outperformed the S&P 500 over that time by returning 14% per year on average versus the index’s 13.8% annualized gains.

But while Smead has used Buffett and Munger’s strategy for success to the upside, he also takes note when Buffett is preparing for downside risk. And he believes that’s the case right now as Buffett continues to substantially trim his positions in stocks like Apple and Bank of America.

To Smead, there are a lot of parallels between Buffett’s current actions and his views in 1999. At the height of the dot-com bubble, he opted not to buy into the tech-sector hype and warned that the market was unlikely to continue its torrid pace.

Between July and September 1999, Buffett shared his outlook for the market in a series of talks that were summarized by Fortune’s Carol Loomis in November of that year. In the talks, he argued that stocks had done well in the years leading up to 1999 due to two factors: falling long-term interest rates and rising corporate profits.

But stocks were unlikely to remain on that path, as it would be difficult for corporate profits to grow as much as they had in 1980s and 1990s, even if interest rates did fall, Buffett said. Plus, valuations — which are closely tied to interest-rate levels — had climbed to extremes, hurting the outlook for future returns.

The S&P 500 of course went on to plummet by 50% over the following few years, and an exactly a decade later stood more than 20% its September 1999 values.

Since then, however, investors have enjoyed 15 years of ultra-low interest rates and growing corporate profits — a fact that has Smead worried. Winning streaks like these can’t go on forever.

“The only problem is it’s a curse on long-term S&P 500 performance,” Smead said of the 15-year run. “I’d say there’s probably a 1% chance that over the next 10 or 15 years that people will meet their economic need for funding their future from investing in the S&P 500.”

Baked into Smead’s outlook is an against-consensus view that inflation is set to surge again as the Fed cuts interest rates. While 10-year Treasury rates are on the decline, he thinks an other inflation flare up would drive them up toward 6%. With valuations around all-time highs by many measures, that would mean trouble for the market, he said.

Is inflation a serious threat? The Fed and many other don’t think so, as the labor market shows signs of softening. But Smead thinks the job market is stronger that many give it credit for. A 4.2% unemployment rate, though rising, is still historically low, and businesses still have a hard time finding employees.

All of that considered — that a resurgence in inflation that would push up rates, with valuations being high, and with high corporate growth rates not being able to last forever — Smead is betting on poor index performance going forward. And by his estimation, Buffett is too.

“Look at his behavior,” Smead said. “He’s preparing for the unvirtuous cycle.”

That is to say that, eventually, Smead thinks the market’s advance will reverse and unwind into a feedback loop of selling. Because the index would start to do poorly, people would begin selling it, which would cause its biggest constituents to underperform, prompting selling of those stocks, causing further declines for the index, and so on.

“It goes the other direction at some point,” Smead said. “So many of the variables that Buffett talked about in 1999 are in place to serve as a curse rather than as a blessing.”