William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Clients and Prospective Clients:

There are very good reasons to avoid investing in emerging markets. Below is a list of some of those reasons:

1. Political Instability (Russia, Honduras, Venezuela, etc.)
2. Small Markets (less liquid)
3. Poorly Regulated
4. Unusual Accounting
5. Currency Risk

However, I’d like to make the case for investing to make money from emerging markets. Five years ago my family and I took a trip to the Bay Islands of Honduras. While there I noticed that one of the only companies selling products to these Honduran Islanders was the Coca-Cola Company by way of the Fanta soda line. It reminded me of 1988 and Warren Buffett stepping outside of his usual proclivity to buy into the stock of a great company when the share price falls into some significant distress. Coke had gone up about five-fold since the bottom in 1982 and sported a trailing 12-month P/E ratio of 18. Buffett bought a major stake in the company and dumbfounded his fondest admirers in the process. Buffett said at that time that he “could go away for ten years” and he’d know that Coke would be doing well.

One of the main reasons that Buffett could have that kind of confidence was that the Berlin Wall was preparing to fall. Countries in Eastern Europe and Latin America were getting political freedom and adopting free-market capitalism. Any improvement in a third-world country’s circumstances was going to create a chance to sell something clean to drink. Nobody does that better than Coca Cola. With Coke he never had to take the risks listed above to make money from emerging markets. He only had to trust the brand, the balance sheet, the distribution system, the economies of scale and the management of the company.

A front page article in last week’s Wall Street Journal that discusses the distribution of drugs in emerging market countries tells you everything you need to know to make money investing in emerging markets in the next ten years. IMS Health reports that in 2003 there was $67.2 billion of prescription pharmaceuticals purchased in emerging market nations. In 2008 it had grown to $152 billion and IMS predicts it will hit $265 billion in 2013. How many companies in the world have the brands, balance sheets, patents, distribution, economies of scale and management to do this? Exporting health to the world will be an incredibly rewarding business both financially and ethically. It will help other businesses succeed by improving the quality and length of life for people in countries ranging from China and India to the smallest countries in Latin America and Africa. The difference this time is the companies that we are interested in like Merck and Pfizer are trading at distressed P/E levels as compared to the last twenty five years. Buffett did well on his investment in Coke, but the drug stocks start this cycle trading at distressed prices the way Buffett usually likes to buy shares.

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 Clients and Prospective Clients:

When a market has been strong, there is no limit to the number of people who will tell you how good it is going to be for the foreseeable future. When a market has gone down for a long time, a multitude will tell you how far down it is going and how long the downtrend will last.

At Smead Capital Management we have developed a term for this that we call a “Well-Known Fact”. By definition (Smead Unabridged Dictionary), a “Well-Known Fact” is a body of economic information which is known by all market participants and has been acted upon by nearly everyone who could care or has the financial wherewithal to care to act. It is best understood through the comments of former Intel CEO, Andy Grove, who said that the best advice he ever got in business came from a professor at the City College of New York. The professor said, “When everyone knows that something is so, nobody knows nothin’.” By nothin’ the professor infers nothing that could do you any good. When everyone believes a fact and has acted on it to an extreme, nothing good can come to you from believing it from an investment standpoint.

Here is a series of “Well-Known Facts” from recent history. Also noted are the assets that were purchased to act on the fact and the end result of the extreme:

Fact 1: The Internet will change our lives. — Asset Purchased: Tech Stocks — Result: From the peak of early 2000, tech stocks fell 80% in 2.5 years.

Fact 2: Residential Real Estate only goes up. — Asset Purchased: Homes in sunshine states of Arizona, Florida, Nevada and California. — Result: 40-50% price drops and a majority of the nation’s foreclosures.

Fact 3: Brazil, Russia, India and China (BRIC) will grow faster than the industrialized world. — Assets Purchased: Commodities and Emerging Market Mutual Funds. — Result: Commodities drop 60-80% and Emerging Markets fall 50-70%.

At the extreme, whatever value that is connected to the assets involved with the “well-known fact” doesn’t matter in either direction and there is no shortage of both expert and non-expert opinion on how high or low the asset prices will go. Henry Blodgett saw the moon for Qualcomm and internet stocks in 1999. No shortage of cable shows taught you to “Flip this House” in 2005. And in 2008, Goldman Sachs’ Oil analyst put a $200-250 price possibility on a barrel of oil. Not to mention T. Boone Pickens, who has been attempting to talk oil prices up since it peaked at $147 per barrel last year.

In the opinion of SCM, here is the new “Well-Known Fact”.

Fact 4: The massive amount of borrowing attached to homes and personal finances in the U.S. over the last ten years dooms us to a three to four-year recession/depression which is not treatable by policy makers and could ultimately cause a total collapse of our financial system. — Assets Purchased: U.S. Treasury Bills, Notes and Bonds; Gold and “virtuous non-U.S. currencies”. — Assets Sold: Common Stocks including the finest companies in America. – Experts: Nouriel Roubini, Jimmy Rogers, Marc Faber, etc., etc. etc.

The T-bills and gold are easy for us to see through. There is a bubble of fear and uncertainty. Therefore, any asset which seems to give protection against fear should get way over-priced at the height of the fear. We wonder how people are going to feel about earning little or no interest for years. I drove by a guy on Pima Road in North Scottsdale today selling Safes on the side of the road. Gun sales are through the roof. These actually make more sense to me than the money-market funds, savings accounts, CD’s and T-bills. If the premier U.S. companies don’t survive and prosper, there will be no tax revenue to insure deposits, back money-market funds and redeem government debt. If our Disney, Abbott Labs and WalMart don’t make it, you need a one-acre garden, a nearby water supply and a set of big guns and lots of ammo.

As bad as this decline has beaten our stocks in the short-run, you’d think that we wouldn’t love it just as much as the other “well-known facts”. You’d be wrong. This one is possibly setting up faithful and persevering blue-chip stock investors for the positive ride of their lifetime. First, today’s Wall Street Journal is talking about an additional decline of more than 20% off a stock market which has been pummeled more than any market other than the 1929-32 “Great Depression” decline. Second, sentiment polls from the American Association of Individual Investors and Bespoke Research show that a MAJORITY of market participants believe that the stock market will fall more than 20% from here. Third, our wonderful and well-trained clients have called me more times in the last two weeks to tell me that the market is going down more and is going down for another one to two years. All these prognostications coming from folks we’ve worked for for years and have n ever had an personal opinion about the short-term stock market direction prior to this year.Fourth, there is more cash on the sidelines in money-market funds relative to total U.S. stock market capitalization than any time in the last 60 years.

We could go on all day with additional evidence, but we think you get the picture. We believe there has probably never been a better day to buy quality U.S. stocks (for a two to three-year holding period) in our lifetime than today. The reason is that everyone knows that the opposite is so and, therefore, “nobody knows nothin’.”

BUY-BUY-BUY

Warm 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

Dear Clients and Prospective Clients:

Before the next ten years of successful stock market investing gets away from us, we at Smead Capital Management would like to remind everyone that the purpose for investing is to build wealth to enhance future purchasing power. If you watch investment shows on T.V. or read investment magazines, newspapers or websites, you’d think that the object of the game is to be smart. However, let’s look at some of today’s key topics to see what is currently considered dumb and smart in the investment world. Then, let’s ask if they build wealth over long periods of time.

Ultra-Smart—Sitting in Cash, preferably U.S. Treasuries.
Those who were smart in 2008 held inordinate parts of their assets in cash or treasuries and missed some part of the stock market’s horrendous decline. They earned anywhere from 3% interest to as low as 0% toward the end of the year. It can be a very smart strategy in the short run, but has always been blown away as soon as everything returns to something more normal. We believe when normality returns those who sat in cash will have to stare longingly at the portfolios of their “dumb” friends who sat through abusive declines in the value of their blue chip stocks to get long-term returns averaging 10%.

Smart—Trading in and out of stocks.
Wade Cook hasn’t been out of business that long, but it is hard for you all to remember his advertisements which told people to “cash flow” their stocks. He said, “Buy a stock at $1 and sell it at $2, wait for it to go back down to $1 and do it again.” Wade spent time in jail for his misrepresentations, but the “Fast Money” people or Jim Cramer’s followers won’t. You’d have to be pretty “dumb” to sit through last year’s volatility when you could have been trading the enormous market swings (mostly down swings, they fail to mention). I think that if you add up the gains and losses, commissions taxes and you find that trading almost never builds wealth (unless your Charles Schwab).

Smart—Participating in highly sophisticated and esoteric asset classes.
Commodities, hedge funds, private equity, emerging international markets, short selling and the like always look and sound smart because of the exclusivity and complexity. The exclusivity and complexity contributes to dramatically higher participation costs (a leading cause of wealth destruction) and who knows if anyone ends up building wealth (see Bernard Madoff).

Smart—Gold.
Gold was $1000 an ounce when I was in college 30 years ago. It is $870 today. Am I missing something?

Dumb—Buy and Hold Blue Chip Stocks.
How could anyone be so dumb as to buy and hold the finest companies in the world like Disney or Microsoft or Nordstrom? Don’t they know that we have the worst recession since the 1930’s? Don’t they know what Professor Roubini says? Haven’t they been in China with Jimmy Rogers? Didn’t they see how bad it was last year?

Dumb—Buy American Stocks
Everyone knows that the smart people are investing in China and emerging markets! They must know that Warren Buffett will be wrong this time (NY Times Op-Ed Oct. 16, 2008—Buy American, I did). Didn’t he get wealthy?

Dumb—Leaving your stocks to your alma-mater.
I love reading the stories of the elderly man or woman who leaves their stock certificates to their favorite charity. A schoolmarm who left the school millions or the guy who left the Union Gospel Mission thousands and thousands of dollars of utility stocks buried under his mobile home. It was never gold or trading techniques or complex investments they left, it was common stocks.

At any given time the best investments can look smart or dumb depending on when you look and where we are in the market. However when traditionally solid wealth creation disciplines are challenged, it could be time to get excited. We love what we do at SCM and we hope you all join us in this worthy and hopefully wealth building endeavor.

Happy New Year!

William Smead

William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

Andy Grove was the CEO of Intel for many years and was asked what the best advice was that he’d ever been given in business. His answer was that a professor at the City College of New York taught him that “When everyone knows that something is so, nobody knows nothing”. It means that when the crowd of market participants reach more than 80% agreement on matters of business or investng, you have to disagree with them and do the opposite of what the crowd is doing.

A few examples for newer readers. When everyone thought in 1998-1999 that the profit to be made from tech investments was unlimited, you had to flee the area. A year ago when investors were rabid for international stocks (especially emerging markets), you had to assume the bubble would burst. Last summer when Oil hit $145 per barrel and commodities were flying high, we warned everyone who would listen to get clear and forget you’d ever heard of BHP Billiton, Transocean, Mosaic and Freeport McMoran.

At Smead Capital Management we crave the opportunities created by this phenomena we call a ”Well-Known Fact”, which is a body of economic information which is known by all participants and has been acted on by the 80% majority. Unfortunately, for the last 10 years, most of the “Well-Known Facts” were things to avoid as opposed to sectors made attractive for new investments. Avoiding overvalued areas saves you money while pursuing undevalued sectors could make us wealthy.

I’m pleased to report the latest “Well-Known Fact”. The “new” fact is that the recession which started a year ago is going to be the longest and deepest since the 1930′s. Therefore, the crowd of investors assume that the most violent decline since the 1930′s in the U.S. stock market (from October of 2007 to November 20th of 2008) is not good enough to discount all the bad news which will come for however many months that the recession lasts. Individual investors are approaching having 2.5 times as much of their aggregate household assets in treasury bills, checking, savings and certificates of deposit as they own directly in common stock. It is almost the exact opposite of the top of the market at the end of 1999 when they owned $10 trillion of common stock directly and had $4 trillion in the safest and historically lowest paying instruments. Warren Buffett says, “Uncertainty is the friend of the buyer of long-term values” and “So if you wait for the robins, spring will be over”.

Here is our opinion based on the current “Well-Known Fact”:

Buy quality U.S. stocks with balance sheet strength and powerful brands.

Assume that Treasury interest rates will rise dramatically in the next two years.

Assume that recently hot sectors like commodities, oil, international/emerging market and gold will be dead money in the “Next Great U.S. Stock Market.”

Assume the largest self-help and psychological counseling group in the U.S. in 2010 will be made up of the folks who sat on low interest rate money market and “cash is king” investments at the end of 2008 and watched a once in a lifetime fire sale in America’s finest companies pass them by.

Lastly, if we don’t currently manage money for you and your portfolio doesn’t line up well with this advice, don’t waste time getting the dust off your feet before you call us.

Best Wishes,

William Smead

We believe we will succeed over the next ten years because the quality and financial strength of our companies leads them to survival and survival leads to prosperity. The number one damager of long-term profitability is competition. How many new drug companies are being funded by the IPO’s of Common Stock? How many phone and cable companies? How many brand-name retailers are appearing on the seen? How many new asset custodians and money managers? How many software or technology consulting firms are debuting? The answer is nearly zero and in fact the opposite is happening! Our companies are seeing their competitors decline or disappear in direct industry competition and investment alternatives are dropping like flies. How about those hot commodities and commodity-related stocks? How about those emerging international stock markets? How about those glamour tech stocks?

Is the population of the world shrinking? In the U.S. we are delivering the most babies (4.3 million last year) since the height of the baby boom in 1957. China and India should create massive new markets for pharmaceuticals, entertainment, software, consulting and money management/custodianship. More customers and fewer competitors, sounds like a dream come true.

History is on our side! U.S. investors were doomed to succeed in 1932, 1942, 1974, 1982 and 1990. They were blessed to fail in 1929, 1966 and 1999.

We have no idea when this panic hits bottom. However, if you can survive this, we believe you are doomed to succeed!

Warmest regards,

William Smead