William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

Three years ago Americans were spending all of their after-tax paycheck and were borrowing above and beyond take-home pay to attain a certain standard of living. Most of the money came from loans against home equity or credit cards which were paid off by borrowing through home equity loans or mortgage refinancing. At Smead Capital Management, we think in terms of the U.S. going from a 104% spending society in 2006 to a 95% spending society today. Government statistics show that above and beyond our 401(k) or 403(b) contributions we are saving close to 5% of our after-tax paycheck. In less than a year we have reduced consumption at the household level by 9%. Since Household Consumption has made up 70% of Gross Domestic Product in recent years, this puts a 6.3% drag on the GDP comparisons beginning in early fall of 2008. Notice that the fourth quarter 2008 GDP figure was revised to -6.3%. This is very similar to our estimate of reset spending patterns.

All companies will need to deal with this reset of spending patterns. The U.S. automobile industry is having a very hard time with this reset because auto purchases are a big-ticket item. A $200 to $1000 per month payment doesn’t fit very well into the budgets of the newly reset households. People are holding on to cars for longer than nine years on average and auto repair businesses are flourishing. Auto industry experts talk about a sales level of 9 to 10 million vehicles sold in the U.S. in 2009 which is down from 15 to 16 million vehicles in 2006. It will take time for them to work through this reset as folks naturally err on the side of being overly conservative for awhile.

We like to think about who is being the least affected by the reset in spending patterns or who has put their companies the farthest ahead in adapting to the new patterns. We expect them to be the leaders of the “Next Great U.S. Stock Market” because we believe they will be maximizing their brand and balance sheet strength during the reset and will hit the ground running when we begin to grow from the reset spending levels. The loss of blockbuster drug revenue due to patents running out has forced Merck and Pfizer to flex their balance sheet muscle to buy Schering-Plough and Wyeth, respectively. People have reduced their doctor visits and cut back in healthcare, but it is much less than a 9% cutback. These companies get a huge part of their income from outside the country and the two most populated countries of China and India are becoming wealthy enough to demand the best in pharmaceutical products for the first time in their history.

Starbuck’s has adapted with a discount membership card, instant coffee and breakfast value meals. They’ve closed poor performing locations and cut corporate expenses. Walmart is grabbing market share as it reminds everyone to “Save Money, Live Better.” The folks who go to Walmart now, who used to think that they were above the fray, will add numerous spur of the moment purchases once the economy rebounds or stops contracting sometime later this year or early next year. Disney will control more and more eyeballs through ESPN, ABC and Disney Channel because people are staying home and watching more T.V. When advertising revenue rebounds, Disney will have gained market share. They will ultimately pick up customers from less well financed theme parks who fail or downsize as well as movie production companies that no longer get funded. Movie ticket sales are up 16% year over year as we escape to the theatres.

There are many more stories among our companies to tell associated with the new household consumption levels, but we believe our portfolios could take advantage of what the future brings despite this difficult transition from households hitting the spending reset button.

Best Wishes,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

I read an interesting book recently by Russell Napier called The Anatomy of a Bear Market. He sought to dispel myths about what happens at low points in the stock market. He examined the market based on the point in time when you would have done the best over the following twenty years. He focused on July of 1932, April of 1942 and August of 1982. His thesis wasn’t that buying at a major low point is all that mattered, but rather the best starting points produced forward success. For this reason he left out the market low in December of 1974.

Once he had identified the best points to enter the market over the last 108 years, he then researched what was going on in the economy. He wanted to dispel the myth that there wasn’t any good news at the bottom or best buying point. He found a few good clues to look at to see if the low point had forward looking merit. First, he found that commodity prices firm up around the bottom. Second, auto sales pick up. Third, major companies cut their dividends close to the bottom. For example, General Electric and AT&T cut their dividend within a month of the bottom in 1932. Lastly, overall business shows some life.

Where are we now? The decline in stocks of 53% from October of 2007 to March 9th 2009 is the worst decline since the 1930’s. Commodity prices have firmed as Oil and Copper prices have rebounded. Auto sales have not yet rebounded. General Electric, Alcoa, Wells Fargo and other major companies cut their dividend. Overall business conditions are showing signs of improvement. Durable goods orders were better than expected and retail sales were better in February than expected. Home sales were up on both new and existing homes. And the most active home sales are in California, Arizona, Nevada and Florida. We’ve had four of our clients buy a home in the Phoenix Valley in the last 60 days! Can you hear the rhyme?

We continue to believe that there has never been a better time for investors with a three to five-year outlook to buy quality common stocks. Be careful. If you wait for auto sales to improve, you could get caught in a melt up. Remember, there is more money on the sidelines than at past bottoms on both an absolute and relative basis. Did I forget to mention that the cash on the sidelines pays very little in interest?

Warmest Regards,

William Smead

The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

If you can’t see the video above, click here to watch the segment

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

Baby Boomer’s kids are coming of age. While boomers are enjoying 50th and 60th birthday party celebrations in abundance, their children are getting married and having children. What is this massive reset of our real estate markets and stock market doing in relation to these large population groups?

Boomer Kids

1. Homes are affordable again.
2. First-time homebuyer tax credit is $8000.
3. Low mortgage rates around 5%.
4. Stocks are the cheapest they’ve been in 27 years for buying in 401K’s.

Boomers

1. Don’t have to loan the kids the money to buy a house.
2. Don’t have to have the kids live with you.
3. Get to baby sit grandkids and they are more fun anyway.
4. Lower property taxes in the future.
5. Way above average stock market probabilities over the next ten years.
6. Bargain retirement homes in sunshine states.
7. Vacation deals everywhere you turn.
8. Cheap Motorhomes for sale.

Here are the thoughts of fellow portfolio manager, Jim O’Shaughnessy, in his column titled “A Generational Opportunity” on March 17th:

“I recently had dinner with a client who told me that stocks had not performed well over the last 40 years. At first I suspected that she was generalizing from the recent pummeling equity markets have experienced — after all, this is a time frame that included two of the biggest bull markets in history! Yet, when I went to the data, I found out that she was absolutely right. The 40 years ending February 2009 were the second worst 40-year period for equities since 1900, with only the 40 years ending December 1941 doing worse!

Let’s put this into perspective. The 40 years ending in 1941 included the stock market panic of 1907, which drove down the Dow Jones Industrial Average nearly 38 percent; the World War I Era, where the period between 1910 and 1919 was one of the worst ever for stocks; AND, oh yes, the Great Depression. Finally, icing on the 40-year cake, the Japanese bombed Pearl Harbor on December 7, 1941. How could these last 40 years even begin to match that? Alas, they did.”

In other words, we are getting the same kind of buying opportunity in common stocks as you had in late 1941. This is when the stock market was not only depressed, but we were losing a huge two-front World War and considering whether to learn German or Japanese to get by.

Which media outlet is covering this story?

Warmest Regards,

William Smead

The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

Everyone who goes to college wants to earn a bachelors degree. Many young people show up at college as freshmen and get off to a very difficult start. I was one of those freshmen. My first set of mid-semester tests showed that I had learned the subject matter in an underwhelming way. I was unable to separate the significant from the insignificant. I also tried to get by with an unusually good memory and a below average amount of time spent on studies. Fortunately, my professors had seen many a cocky 18-year old roll through the halls of Whitman College and took mercy on me. They said that they would grade me for the semester on improvement and that I needed to buckle down.

The first year of college you have four main problems. First, you are forced to establish a life pattern without the walls to bounce between which had been set up for you by your parents and your community. Second, the complexity of the classes and the mental disciplines to be learned were geometrically tougher than high school classes were. Third, you weren’t yet trained to cull and analyze information for what is important, which caused you to dwell on the interesting but seldom important parts of the material. Fourth, the people I was competing with for grades were folks who came into the process with much better study skills and way fewer sports and social interests than yours truly.

Why do I bring this up in an investment blog? This huge decline in the stock market the last 18 months has thrown us outside the walls we used to bounce off of. Many of us want to transfer to an easier school (CDs, Money-Market funds, T-bills, etc.). We are overwhelmed by 24-hour news and the internet burying us in information about what might happen in the short run and some of the most believable opinions are very complex. We are more attuned to the information about the next couple of months than we are about the next 5 to 10 years. Lastly, fear is driving us to extrapolate the negative and envy those who have temporarily sidestepped some of the decline. It seems like they have better investment study skills.

Since I turned things around and graduated with a solid GPA from an academically tough school, please consider the opinions of Smead Capital Management on what doesn’t matter in the long run and what does.

What doesn’t matter!
1) Stocks could go down more in the short run.
2) The economic contraction could last longer than the non-pessimists think.
3) Inflation could run wild if we have a strong recovery.
4) Oil could have a big price increase in a strong recovery.

What does matter!
1) When U.S. stocks have produced a negative return looking back over the prior ten years, they have produced a positive 14.5% return on average the following ten years (Four prior instances–1875, 1895, 1919, 1974). The average of these four events has quadrupled stock portfolios in 10 years if dividends where reinvested. Stay in school and don’t transfer. Buy if you have cash.
2) Stocks are cheap in relation to normalized profits and U.S. economic output (GDP).
3) There is 50% more cash on the sidelines at this low point relative to stock market capitalization than there was at the bottom in 1974.
4) Companies are starting to buy each other (IBM is buying Sun Microsystems, Pfizer buying Wyeth and Merck buying Schering Plough).
5) Oil was a bubble as recently as last year and bubble markets which break take years to put back together. Just ask investors in the Tech-heavy NASDAQ, which peaked at 5000 early in the year 2000, who learned the hard way with no significant success in nine years. I’m glad that commodities are not collapsing in price, but it will be years before they are the place to be again in our opinion.

Hang in there because we will all be sophomores soon.

Warmest Regards,

William Smead

The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.