William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

Since the bottom of the stock market usually comes at the height of the economic or political calamity of that era I thought it would be good to review past major stock market low points. In this way we can compare our current misery with past misery since “Misery loves company”.

The bottom in July of 1932 at 41.22 on the Dow Jones Industrial average was one year shy of the end of the biggest economic contractions in U.S. history. The economy was contracting at more than 10% for its third year in a row. Unemployment skyrocketed to 20%, while 40% of U.S. banks failed. The average stock had fallen more than 80% in the prior two years and 8 months. Farm workers were thrown out of work and lost their homes because there was no other place to find work. The U.S. government was doing most of the lending through what was called the Reconstruction Finance Corporation.

The bottom of the stock market in April of 1942 came at 92.92 on the Dow Jones Industrial Average. Stocks had gone down for three years running from a 1939 peak of 155.92. We had surrendered Bataan to Japan, our U.S. Naval fleet was crippled at Pearl Harbor and the British had surrendered Singapore. The U.S. was woefully ill equipped to produce the war goods and armaments needed to fight the Germans and the Japanese all around the globe. Hitler was having his way everywhere in Continental Europe. Severe shortages of oil, rubber and other commodities made production slow and threatened us with runaway inflation. Most thought a depression would follow even if we won the war.

At the bottom on Dec. 6th, 1974 the Dow Jones Industrial Average was at 577.60 and the market had fallen 45% over two calendar years. The list of reasons to not invest in stocks sounded very familiar. Oil shortages and inflation psychology ruled the day. The banking system lacked liquidity. War was feared in the Middle East. Interest rates had soared to double digit rates. The President (Richard Nixon) had resigned in disgrace in August and the last helicopter to leave the U.S. Embassy from Vietnam in 1974 has been memorialized in the movie, “Good Morning Vietnam”.

The Dow Jones Industrial Average bottomed at 776.92 on August 12th, 1982. It was the fourth bear market since 1966 in a 16-year stretch. Unemployment was 10% and inflation had run at 10% or greater for the prior three years running. Heavy industry like timber, aluminum, steel, coal, automobiles and others were in a depression. Interest rates to “prime” borrowers peaked at 20% and mortgage rates peaked around 17%. Homebuilding was a disaster, even though millions of baby boomers were going to need homes soon. Foreclosed homes were for sale all over the Seattle area. Government deficits were expected to bankrupt us and major banks were teetering on extinction.

Here are the five-year gains coming off these prior major low points, not counting dividends:

July 1932-July 1937 — 41.22 to 182.00 Gain= 341%

April 1942-April 1947 — 92.92 to 175 Gain=88%

December 1974-December — 1979 577.6 to 830 Gain=44%

August 1982- August 1987 — 776.92 to 2500 Gain=222%

November 2008-November 2013 — Gain Unknown

Merry Christmas and Happy Holidays from all of us at Smead Capital Management!

William Smead

William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

There is an amazing fact in investment analysis. The longer you are right, the greater the amount of intelligence people attribute to you. Along those same lines the more money you make in business, the more intelligent people think you are. It’s like the investment world is perpetually playing the board game LIFE. In the game, if you are lucky enough to get the right roll at the beginning, you become a Doctor. The medical profession had the highest income in the game and made you more likely to win. The game was invented in the 1960′s, when Doctors were the highest paid professionals in town and were also the most educated. Since they had the highest incomes and most years in school, people asked for their opinion on a broad array of subjects under the assumption that their personal success and academic education made their opinion more valuable.
 
At extremes in markets there has usually been someone of stature who felt early on that what has happened would happen. The longer that the trend continued and the longer that the person of stature continued to predict its continuation, the more intelligence investors attached to them. A few historical examples are in order. In the very high interest days of the early 1980′s two economists, Dr. Henry Kaufman and Dr. Albert Wojinalower, correctly predicted that the Federal Reserve and its leader Paul Volcker would tighten credit and raise interest rates high enough to break the back of inflation. They were called Dr. Doom and Dr. Death because of their bearish views on the bond market and the economy. Unfortunately for them (at the time that they were considered the most intelligent form their correct predictions) they were predicting 22 to 25% Prime interest rates at the peak in 1981 and told everyone to stay out of bonds at the single best time to buy them in U.S. history !
 
Mary Meeker and Henry Blodget were technology stock analysts in the late 1990′s and rode the dot-com bubble for everything it was worth. Once again they were idolized and ascribed great intelligence until the bubble burst and they stayed bullish a long way into the crash. They crushed their fan club in the process. More recently, the oil analysts at Goldman Sach’s were riding high from predicting in 2005 that oil would climb immensely in the coming years. They predicted $90 per barrel oil and ratcheted that prediction up as oil exceeded that target in 2007 and 2008. When oil reached $145 per barrel, they were considered total geniuses and flatly predicted a run as high as $200. I haven’t heard a word about them lately as oil is below $50.
 
Today, a banking analyst at Oppenheimer by the name of Meredith Whitney and a New York University Professor by the name of Nouriel Roubini, who correctly predicted much of the difficulty experienced in the banking and financial companies the last two years, move the markets every time they appear on CNBC or Bloomberg. Their intelligence meter is through the roof and the respect the markets pay them matches it. We at SCM assume that they will be singing the same tune all the way through the bottoming process and could be scaring investors away from financial companies at the bottom the same way that Henry Kaufman and Albert Wojinalower did with bonds in 1981! Remember, the longer a trend is in place the more risky it is to bet that it will continue and all of us are human, even the experts you see and hear on television.

Best Wishes in this Holiday Season,

William Smead