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Dear Fellow Investors:

When I was 5 years old I got a life saver stuck in my throat while grocery shopping with my parents. My Dad grabbed me by the ankles and turned me upside down. He shook me a couple of times until the sweet lozenge dislodged. We just did the same thing in the US stock market in the last week.

We at Smead Capital Management believe that the market has an uninterrupted BRIC trade lozenge stuck in its throat. This lozenge causes the US stock market to choke on over-priced oil, basic materials and industrial shares. While we are seeing a textbook economic recovery, we are using much less gasoline than a year ago. We are also embarking into the world of electric cars. Why is the price of a commodity going up when its best customer is using less?

In our opinion, the answer is that the capital market participants believe as deeply in uninterrupted growth in China as I believed in the good flavor of orange and cherry flavored life savers at age five. The only way to get it out of me was to shake me and the only way to change the investment trend is to shake it with high volatility. The Chinese stock market, as represented by the Shanghai Composite, fell 1.9% last night in overseas trading. That’s a decline of 20% in the last nine months, qualifying for bear market territory. Stock markets have a tendency to look out one year on economic activity.

Ignore the noise and enjoy owning America’s fine companies in areas like consumer, banking and healthcare. When we get this BRIC trade out of our throats, we believe under-priced non-cyclicals will take over market leadership.

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:

I’ve always felt very fortunate to have received a solid education at Whitman College in Walla Walla, WA. In Micro- and Macroeconomics, we studied marginal supply and marginal demand. In calculus, we learned the mathematics surrounding the rate of change occurring at the margin. We learned that producers and their competitors produce until marginal profit moves to zero. What was so important about the things which happened at the margin?

We at Smead Capital Management have been pondering the interview Jim Chanos did with Charlie Rose on April 12, 2010. He explained to a very frustrated Mr. Rose that the seeds of a credit driven bubble in the commercial and residential real estate markets in China are about to burst. This will happen, he explains, despite the best efforts of the communist government to combat the bubble and ultimately deal with the effects. In this “treadmill to hell”, Chanos shows that the bubble in real estate there is as egregious as the subprime bubble we had in 2005-07 in the US.

However, to make money from these phenomena unwinding, Chanos is not placing most of his bets against Chinese companies. When asked by Mr. Rose what he is selling short, Chanos said, “But probably more importantly from an investment point of view this has implications for the people selling stuff to China, commodity, people – anything that are selling things to people who put up high-rise buildings, cement, glass, copper. That’s where you’re going to see probably a step function down in demand – steel, because right now it’s all going to China.” To understand why he is shorting commodities and commodity producers to benefit from a dramatic slowdown in GDP growth in China, you have to understand how important demand at the margin is to the market price of copper or steel or oil. Un-interrupted GDP growth in China and India has been at the forefront of investor confidence in commodities and emerging stock markets. Therefore, at the margin, massive quantities of worldwide capital are committed to these investments. This commitment is tied to un-interrupted growth and could disappear very fast. Chanos says, “And then there’s this precarious tipping point where suddenly you can’t sell a project. And then it’s just as if everyone from the port side of the cruise ship goes to the starboard side of the cruise ship all at once.”If institutional investors felt that marginal demand for commodities was going to be impacted by an economic slowdown in China, you could get an outsized move down in commodity prices. Like when the tech stock bubble died, you’d suddenly had no bid.

We at SCM can give you two recent examples of similar phenomena. From 2001-2005 in Phoenix, you could see how the residential and commercial real estate booms were affecting the overall economy at the margin. We estimated that as much as 30% of the economy of Phoenix was tied to the building, financing, selling and maintenance of commercial and residential real estate. Prior to demand disappearing at the margin in 2006, there were an amazing number of vehicles driving around Arizona highways with contractor logos on the side. Today, you have to look vigilantly to find logo-laced trucks associated with the building and maintenance of homes. The Phoenix economy cratered when home prices cratered and commercial properties followed right behind.

In the fall of 2008, toxic loans on the books of the major US financial institutions created a panic and total stock market meltdown. At the margin, retail sales fell 10% on a year over year basis by the end of 2008. In turn, purchases not being made at the margin triggered lower sales and profits at companies all over the country. Massive nationwide layoffs ensued as producers, distributors and retailers adjusted to the change in demand. The unemployment rate in the US rose from around 5% in 2006 to over 10% in 2009. Most folks didn’t lose their job, but at the margin everyone’s behavior was impacted by the folks that did. Remember, the vast majority of everything that went on in the US economy in 2008 did go on in 2009, but at the margin everyone moved to the other side of the boat.

Chanos claims that 50-60% of the GDP of China is tied directly to residential and commercial real estate. When investment capital sees a slowdown in construction, it will cause the same kind of loss of confidence in the commodity and emerging market thesis, at the margin, which we saw in Phoenix in 2006-07 and we saw in the US economy in 2008-09. As in everything in economics, some will benefit and some will lose. We like US large capitalization recession-resistant “quality” stocks as defined by our eight criteria and would avoid commodities, commodity producers, commodity exporting nations and construction-related heavy industrial companies. Remember, most of what went on before will still go on, but at the margin is where the confidence is set or lost.

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:

Last week those of us at Smead Capital Management got to listen to the wisdom of Warren Buffett and Hank Paulson. We also read some terrific economic history from Joel Kotkin in a column called “America on the Rise”. I’d like to share some of their thoughts and connect them. In this way we can help folks understand why we think this is one of the best times to own US high quality common stocks by looking for Hall of Fame Companies and use long-term holding periods.

Mr. Buffett interviewed Hank Paulson in Omaha at a big Chamber of Commerce gathering. They spent most of their time talking about the tough decisions which Paulson spearheaded in the fall of 2008 as US Treasury Secretary in the Bush administration to avert an economic catastrophe. In the second half of the talk, Hank shared some thoughts which really solidified our feelings about the “group think” which has a tendency to dominate investment decisions in the short run. He said, “Every other economy, including China, has more significant problems than we do.” You might need to read what he said again. Paulson was Treasury Secretary from June of 2006 to January of 2009 and had been the leader of Goldman Sachs in the years just prior. We have just spent the last two years hearing from a wide variety of economic pundits. Almost all of them have told us that the cleansing of 2007 through 2009 and the overhanging debt of the past 15 years is ushering in the decline of American economic glory. Whether it is “seven lean years” or the “new normal”, we’ve heard it and seen most of the people who manage money adopt it as the foundation of what drives their investments and asset allocation.

Kotkin piggybacks Paulson by demystifying China’s future and rebuts George Will’s recent writing about American “declinism”. He does this by sharing some economic history and by sharing key attributes of long-term economic growth.

“Rarely mentioned in such analyses is China’s own aging problem. The population of the People’s Republic will be considerably older than the U.S. by 2050. It also has far more boys than girls–a rather insidious problem. Among the younger generation there are already an estimated 24 million more men of marrying age than women. This is not going to end well–except perhaps for investors in prostitution and pornography.”

“In the longer term demographic trends actually place the U.S. in a relatively strong position. By the end of the first half of the 21st century, the American population aged 15 to 64–essentially your economically active cohort–are projected to grow by 42%; China’s will shrink by 10%. Comparisons with other competitors are even larger, with the E.U. shrinking by 25%, Korea by 30% and Japan by a remarkable 44%.”

Kotkin goes on to remind us how wrong the punditry has been in past cycles. Remember when Japan was eating our lunch in the 1980’s?

“The Japanese experience best illustrates how wrong punditry can be. Back in the 1970s and 1980s it was commonplace for pundits–particularly on the left–to predict Japan’s ascendance into world leadership. At the time distinguished commentators like George Lodge, Lester Thurow and Robert Reich all pointed to Europe and Japan as the nations slated to beat the U.S. on the economic battlefield. “Japan is replacing America as the world’s strongest economic power,” one prominent scholar told a Joint Economic Committee of Congress in 1986. “It is in everyone’s interest that the transition goes smoothly.”

He (Kotkin) then reminded all of us what could go wrong with China’s economic miracle and then shared his opinion of the future.

“China’s social problems will be further exacerbated by a huge, largely ill-educated restive peasant class still living in poverty. Of course America too has many problems–with stunted upward mobility, the skill levels of its workforce, its fiscal situation. But the U.S., as the Japanese scholar Fuji Kamiya once noted, possesses sokojikara, a self-renewing capacity unmatched by any country.”

“As we enter the next few decades of the new millennium, I would bet on a more youthful, still resource-rich and democratic America to maintain its preeminence even in a world where economic power continues to shift from its historic home in Europe to Asia.”

Are the pessimistic and dour pundits of today right this time? Should we be congregating our investments in the BRIC countries (Brazil, Russia, India and China) or dialing down our expectations for investment returns in the US investment markets because the inevitable “declinism” of the US economy has set in? This “group think” robs investors of the urge to concentrate on the strong balance sheet, wide moat and powerful brand companies which weather recessions and have more potential to be “Hall of Fame companies”. We believe anything that stops us from owning some of the best companies in the world this close to the aftermath of a terrible consumer-led recession is robbing us of future success.

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.

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The information contained in this tv appearance 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 tv appearance 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:

At the start of the year, we at Smead Capital Management predicted that 2009 would be like 1988. In the aftermath of the 1987 Stock Market Crash the market thrashed around violently in both directions before settling at the end of the year with about a 10% gain counting dividends. People had to put up with a great deal of volatility to earn that gain in 1988 and we felt that 2009 would look similar. We are halfway through the year and 2009 appears to be 1988 on steroids. The down swings and upswings have already been huge, but the stock market is about where it started the year.

We also have felt that the economy would begin to grow again once we got past the massive “reset” in consumer spending which started in September and October of 2008. Spending figures are typically measured against the prior year. We have continued to believe the year over year retail sales comparisons will be positive in the fourth quarter of this year as compared to the economic coma figures of late 2008. The stock market is an anticipatory vehicle and we expected that the market’s rally would begin six to nine months before the economy improved. It did in fact bottom around March 9th or six to seven months before the consumer spending reset turned one year old.

There have been some big surprises for us this year and those surprises are a big part of the market’s recent pullback. We believe that the economic “reset” is going to become the kickoff of an era of slower growth and unwillingness on the part of the average consumer to take on debt. In this slow and consistent era we expect a substantial premium to be placed on the companies which perform well despite the new environment and borrowing reluctance. In the prior era, investors basked in the belief that the growth in emerging market countries like Brazil, Russia, India and China would drive worldwide growth, thus placing a premium on the production and distribution of natural resources like oil, basic materials and fertilizer. These cyclical industries out-performed the market from 2004-2008, got clobbered from the second half of 2008 into the new year and came roaring back in the rally off of the March bottom.

If we are right and investors resign themselves at some point to the new environment, the normal premium for strong balance sheets, brand recognition and consistency of customer base should be reestablished. This means lower P/E ratios for cyclical businesses and higher P/E ratios for companies that meet our strict 8 criteria. What normally is highly valued by investors will take its usual place in the hierarchy of common stocks. We believe this current correction in the market is the beginning of a flow of money away from investor attempts to revive the BRIC trade. We expect to move toward a premium for large quality blue chip companies with relatively non-cyclical businesses. We wait patiently.

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.