William Smead
Chief Executive Officer
Chief Investment Officer

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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.

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.

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.