William Smead
Chief Executive Officer
Chief Investment Officer

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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.

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William Smead
Chief Executive Officer
Chief Investment Officer

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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

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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.

William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Clients and Prospective Clients:

Reverse psychology is a terrific tool for those of us who fear success. I was a college golfer at little Whitman College in what is now the NCAA Division III level. Our handicaps ranged from about 2 to 10 and for most of us it was a good day if you broke 80 on the links. We had won the conference championship in May, but thanks to a wonderful summer job ($8/hour and lots of overtime) wrapping rolls on the paper machines at Crown Zellerbach, I played very little golf that summer. My wife was my girlfriend back then and she also worked the summer in the paper mill. We worked opposite shifts most of the time and had a very poor social life that summer. As a reward to ourselves, we decided to quit a week early and go up to Vancouver, B.C. and Victoria on a week vacation before I headed back to Walla Walla for my junior year of college. The day after I terminated work and two days before we were to leave for our trip was the Orchid Hills Golf Club Championship in my hometown of Washougal, Washington. It was a 72-hole two weekend tournament which I’d had no success in before. I told Becky that I would play the first weekend and then drop out and not play the following weekend. By now you can guess what happened. I was so relaxed that I shot 74 and 73. I was tied for the lead and would have to cut our one week trip to five days to be back for the final 36 holes. Becky was steamed.

The U.S. stock market had its third best week since World War II last week and our phones have either gone bad or investors have been stopped in their tracks. A large number of investors have sought shelter the last year from our “Abusive Parent” (search “An Abusive Parent” at www.smeadblog.com) and sit in money-market funds, t-bills, CDs and savings accounts. The amount in cash relative to stock market capitalization is twice the level of any bear market low of the last 40 years. The silence is deafening because the stock market could have a run like I had the first weekend of the Club Championship and most of the people on the sidelines will not re-enter the market until huge gains have occurred. Financial and Drug stocks led the way last week and it wouldn’t surprise us if the Drug stocks lead the next great bull market. If you are under-invested, our phone lines are open.

P.S. Just for the record, I shot 77 & 78 the second weekend and ended up in 3rd place in the golf tournament.

Best Wishes,

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.