William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

For a long-term multi-year bull market to exist in stocks in the US, a number of things need to fall into place. Since we at Smead Capital Management enjoy owning high quality large cap US equities for long holding periods and seek to find “Hall of Fame Companies”, we would like to see a long bull run play out over the next 3-5 years. We thought it would be helpful to line up the current “ducks” to see if the markets have done what they need to do for this bull market to last for a long time.

Duck No. 1—Negative Sentiment

When this market sneezes, investors get a cold. A recent 7.5% pullback in the S&P 500 Index caused individual investor sentiment and professional investor sentiment to plunge. Mark Hulbert covered this in a column called “A mid-winter night’s gloom” in which he showed that short-term professional market timer’s had reduced their equity exposure in a short time by 45%. Both the Investor’s Intelligence and American Association of Individual Investor’s (AAII) surveys saw the number of bulls plummet and the number of bears or people looking for a correction soar.

Duck No. 2—Insider’s Positive

The recent pullback in the market saw a big drop off in insider selling (Officers and Directors and Substantial Stockholders of public companies). When the Insider’s are big sellers of dips, beware.

Duck No. 3—Favorable Supply and Demand for Shares

Every week another major acquisition announcement is made. Most are all cash (Terra Industries $4.1 billion) or mostly cash purchases (Berkshire Hathaway’s buy of Burlington Northern). When shares of stock are bought out for cash, the supply of shares outstanding decline. Major stock buyback announcements have been fairly constant (Merck and Amgen in our stable are recent examples) and are being executed, wiping out more supply. In more normal times this supply elimination would be offset by Initial Public Offerings (IPO’s) and Secondary Common Stock offerings. Ask any investment banker, IPO issuance is almost non-existent.

Duck No. 4—Massive Cash on the Sidelines

US households ($7 Trillion), Banks ($1.2 Trillion) And Non-Financial Corporations ($1.8 Trillion ) are holding record levels of cash on their balance sheets. When confidence comes back a significant piece of this amount will either participate in business growth or stock purchases.

Duck No. 5—Negative “Nabobs” have Credibility

Any two-bit economist or market strategist who foresaw the sub-prime meltdown is treated like a god/guru and like they have a crystal ball. They all say the same thing about the US economy in one way or another. The US has seen its best days and we are in for a long deleveraging phase. In their mind commodities and emerging markets are a better place to invest than the best companies in the world domiciled in the USA.

Duck No. 6—The Public Can’t See the Ducks

We believe US household investors and many institutional investors are looking in the rearview mirror at the horrid decline of October 2007-March 2009 and can’t see the ducks lined up. Remember, US households were net liquidators of US common stock last year.

We are very excited to own the companies which fit our eight criteria and look to enjoy the ride as we believe investors will slowly recognize that the “ducks are lined up”.

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. Some of the securities identified and described in this missive are a sample of issuers being currently recommended for suitable clients as of the date of this missive and 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 Fellow Investors:

On November 13th, CNBC writer Jeff Cox shared the findings of a recent survey of major institutional investors put out by Bank of America/Merrill Lynch. These 111 institutional advisors have over $1 trillion in assets under management. Cox wrote, “Even as the US market continues to rally, many institutional investors are trimming their US holdings and putting more money into foreign stocks – especially those in emerging markets.” The primary motivator is a belief among these advisors that economic growth in the US will be anemic going forward. Here is a representative quote from one of the advisors surveyed: “We found a tremendous strategic desire to move away from US equities, particularly large-cap, and toward a more global mandate,” analyst John Haugh wrote in a research note. “Emerging market equities are the most desirable asset class over the next 12 months, with 42% looking to add/increase investment.”

The day before (Nov. 12th), CNBC aired an interview session conducted by Becky Quick at the Columbia Business School where students and faculty asked Bill Gates and Warren Buffett a series of questions. These questions ranged from career advice to visions of the future. In the opinion of those of us at Smead Capital Management, the most important question of the night went to Mr. Buffett as a follow up question from Becky Quick. The student had asked for Buffett’s opinion on the believability of this rally coming off the March lows given that a number of respected market participants were cautious. Buffett reminded everyone in the audience and on television that the best market year of his 67 years in the stock market was 1954. It was a recession year which saw unemployment double and yet saw a 50% gain counting dividends.

Becky followed up by asking about his recent purchases of a company in Israel and in China. She asked, “Are there more opportunities overseas or here in the US?” Buffett’s answer was short and sweet. He said, “I see more opportunity in the United States. We’re the biggest economy and we’re looking for big deals. But I am delighted to find something, you know, whether it’s in China or whether it’s in Israel, like Iscar, or whatever it may be. There are more opportunities in the United States than anyplace else.”

Buffett was not just whistling Dixie with his answer. He had spent $26 billion buying the rest of Burlington Northern the week before and was quoted as saying, “Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.” On November 16th we had learned that Berkshire Hathaway had doubled its position in Walmart and increased its position in Wells Fargo among net stock purchases of $2.3 billion. You probably don’t load your portfolio with the nation’s largest retailer and one of the nation’s biggest real estate lenders if you believe in an “anemic economic recovery”. We don’t know about you, but we have a choice of who we are going to take our economic prognostications from. Is it going to be Warren Buffett, who gets to see and understand as wide a swath of diverse businesses as the Chairman/CEO of one of our nation’s largest conglomerates? Or will it be far less experienced, far less successful and far less informed economic prognosticators who could be a part of a crowded trade?

All this does is make us that much more excited to own our portfolio of Large Cap Value US stocks and continue to enjoy what we believe to be a multi-year and very powerful bull market.

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

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Dear Fellow Investors:

The Wall Street Journal reported on Nov. 2nd that non-financial publicly traded companies were holding more cash on their balance sheets than at any time in the last 40 years. The figure is 9.8% of their combined stock market capitalization. A great deal has been written lately about what officers, directors and substantial shareholders (Insiders) have been doing with holdings of their own companies. We at Smead Capital Management would like to give our take.

Since January 1st of this year there have been a number of large company buyouts. It started with Pfizer buying Wyeth and Merck buying Schering-Plough. It has accelerated last week with Stanley Works buying Black and Decker and Warren Buffett’s Berkshire Hathaway buying the rest of Burlington Northern Railroad for $100 per share in cash and stock. Why are companies so interested in buying competitors? Why is Warren Buffett spending $26 billion to buy the rest of Burlington Northern?

First, we believe they trust that the U.S. economy will make a significant comeback the next three years. Many admired experts have spent the last two years convincing us that the financial sins of the last ten years condemn us to poor economic growth for the next ten years. Here is what Warren Buffett said Tuesday morning about buying Burlington Northern Railroad:

“Our country’s future prosperity depends on its having an efficient and well-maintained rail system,” Buffett said in a press release. “Conversely, America must grow and prosper for railroads to do well.”

“It’s an all-in wager on the economic future of the United States,” he added. “I love these bets.”

Second, these companies’ financial strength allows them to gain market share while prices for common stock are depressed. Trading cash, earning almost nothing, for future corporate profits close to the bottom of the deepest recession since 1982 could look incredibly smart two or three years out. Once what Buffett sees is known to other corporate executives, you could see many buyouts as the 9.8% cash position drops to a more normal reading.

Third, James Grant called low house prices and low stock prices a “shovel-ready stimulus program” back in February. With interest rates low for conducting business and housing the most affordable in my adult lifetime, why can’t the economy do well over the next five to ten years? As we said in our missive called “Pick Your Poison”, what would we rather have, double-digit interest rates/unaffordable homes/less existing debt (1982) or low interest rates/affordable homes/large existing debts (2009)?

Warren Buffett, who we believe is the most successful insider of all time, parted with $26 billion of his company’s stock and cash to bet on future U.S. prosperity on Nov. 3rd. His company is involved in insurance, banking, railroads, food and beverages, credit cards, residential real estate, carpet, jewelry, furniture, manufactured housing, etc. At SCM, we are going to keep our view of the economic future aligned with the insider.

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.