William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Fellow Investors:

A watershed event is something that happens which serves as a point of division or transition between phases. When Paul Volcker tightened credit in 1981 and President Ronald Reagan stood up to the Air Traffic Controllers the same year, it marked the division between the rising inflation of the 1970’s and the disinflationary era which followed. The breaking of the Technology Bubble in early 2000 and the 9/11 attacks of 2001 signaled a new and very difficult decade coming for owners of quality common stock.

We had some very interesting watershed events in Seattle this week. Cy Young-award winning pitcher, Cliff Lee, was traded to the Mariners. Star University of Washington football player, Jake Locker, announced that he would return for his senior season and the Boeing Company successfully flew the new 787 Dreamliner. For a town that is as starved for sports and business success like this one is, these events could signal a new phase.

At Smead Capital Management we see recent events which may indicate a transition or changing phase coming. First, central banks around the world have been buying large quantities of gold bullion. Bloomberg News reports “Central banks, holding about 18 percent of all gold ever mined, are expanding their reserves for the first time in a generation as a nine-year bull market drives prices to a record. The banks will buy 13.8 million ounces (429 metric tons) this year, worth $15.5 billion, for the first net expansion in reserves since 1988, New York-based researcher CPM Group estimates. Gold fell 15 percent that year and took another 15 years to trade again at the same price as central banks from Switzerland to the U.K. cut their holdings.”

CIO Bill Smead on CNBC's Squawk on the Street (12/22/2009)

At the same time, individual investors have gorged themselves on gold bars, gold mining stocks, mutual funds and exchange traded funds which are connected to Gold. I listen to talk radio once in a while and every one of the popular conservative talk shows is pounding advertisements promoting owning Gold. Those same shows were pumping out mortgage commercials in 2006. Where were the Gold ads at $300 per ounce? Hedge fund managers, which as a group are looking for whatever might do well over the next six months, have seen many of their largest and most successful brethren pile into this trade.

It all looks crowded to me and kind of silly in a way. I was on Fox Business with another guest on Dec. 16th who heads a financial firm and he was recommending silver. He liked it because it isn’t up to the same inflation-adjusted price as it was in 1980. Why does anyone buy something as a hedge against inflation, which didn’t protect you from the inflation that happened the last 29 years?
Second, a city named Dubai in the United Arab Emirates has defaulted on billions of dollars of debt it used to build spectacular commercial and residential real estate; a veritable Las Vegas in the Middle East. In a piece written by the Gerson Lehrman Group for Reuters News Service recently, the writers pointed out that this debt default could be a Lehman Brothers event as it pertains to emerging markets.

Dubai is one of the seven Sheikhdoms that make up the United Arab Emirates, a federation that collectively controls a significant percentage of the world’s oil reserves as well as nearly $1-Trillion in Sovereign Wealth. The GLG Group sees three main risks in this default. They felt the projects had become divorced from economic demand. The event reminds everyone that emerging markets carry dramatically more risk and lack transparency. Lastly, it makes you wonder how much you can trust these sovereign wealth funds and how well these “hedge funds” of the Middle East are doing in their asset allocation.

The third watershed event is the Copenhagen Climate Summit. In 1898, a huge pollution problem existed in the major cities of the world. The leaders of London, Paris and New York gathered to figure out what to do about all the horse manure polluting their once great cities. In the New York City area alone, 100,000 horses were dropping 15 to 20 pounds of manure per day. Think of all that manure on a typical summer day of 85 degree heat and 80% humidity. Much like today at Copenhagen, the problem at that time was about to be solved by the marketplace and individual profit motive. From 1900 to 1925, we went from selling 4000 automobiles in the US to 3.5 million and most of the people in New York went from moving people and goods by horse to combustion engine. At SCM, we believe we are in a 10 to 20-year period in which the demand for crude oil and gasoline could drop like hay and feed grain did from 1900 to 1925.

So how are these three events tied together? We believe that investor interest in Gold, Oil, Emerging Markets, and short-term trading are all interconnected. U.S. and international investors got ridiculously over enamored with the US stock market and technology stocks in the late 1990’s. Thanks to those very high valuations, US stocks were doomed to ten years of poor performance. The most avoided markets in late 1999 were prepared to do relatively well. Those were Oil, Gold, Commodities and Emerging Markets. The only people making any significant money in the US stock market in the last decade were trading in and out of the market or in the stocks of companies which benefitted from higher Oil, Gold and Commodity prices or Emerging Market demand for their products. Wealthy investors went to hedge funds to get access to these markets and short-term trading strategies and equity mutual funds managers tried to emulate what they were doing by turning their portfolios over every year searching for an answer.

Therefore, these events could signify that a new phase is coming. If history is any guide, the new phase will see the most out of favor sectors produce the best performance over the next ten years. What countries are the most out of favor? Japan and the United States are the most unpopular internationally. What currency is the most out of favor? The US dollar is everyone’s dog to kick. What are the most unpopular investing style and the most out of favor sector? Buying and holding U.S. large capitalization quality common stocks hasn’t been this unpopular since 1982.

We could transition for awhile as the US stock market adjusts and a new phase is spawned by today’s watershed events, but we are excited by the long-term implications.

Happy New Year,

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 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

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

We at Smead Capital Management are not afraid to admire people who disagree with us. If someone sincerely believes that the stock market is going to do poorly over the next two years, puts their money where their mouth is and sticks to their guns, we have nothing against them. We don’t agree with them, but we can accept their position. They are Bears on the market and they most likely believe that price earnings ratios didn’t get low enough in March to justify a bottom or they believe that the debt accumulated in the last ten years will stifle economic growth and retard the financial system. They go by names like Roubini, Faber, Tice and Rogers. We have no problem with them and we think that the way they have scared everyone is going to make long-term buy and hold investors like us a ton of money.

However, there is a second kind of Bear in the marketplace and we consider them to be dishonest Bears. They are the hedge fund managers, mutual fund managers and individual investors who temporarily own some stocks, but own them with one foot out the door the entire time. This is the “Fast Money” crowd and they are looking for something to own for six weeks to three months. Jim Cramer is there poster child and the discount brokers and stock exchanges are their sponsors. They are the worst kind of momentum investors. We consider them bears because the way they are organized and postured makes for very little likelihood that they or their clients would gain the benefits from holding common stocks for many years. After all, over long stretches of time a significant part of what you make from owning common stocks comes from dividends. In affect they rent stocks rather than own them. They whip around ETFs, are attracted to momentum markets like Gold and Oil and love high levels of volatility. Included in this category are the hyper-inflation folks who are invested in commodity oriented common stocks and think they are going to make a great deal of money from an economic comeback that ruins everything with high levels of inflation like in the late 1970’s and early 1980’s.

We normally wouldn’t really care about these “Closet Bears”. Unfortunately, in this market cycle, they have ended up with way more of the existing capital than normal. It makes sense because after the decline from October of 2007 to March of 2009 most humans who have the courage to participate want to get out of the way quickly if things turn sour again. So you have the “Real Bears” who are in cash and short stocks, mortified from what happened this year. Then you have the “Closet Bears” long stocks for two months at a time with one foot out the door all along.

To be a “Real Bull” you have to be fully invested in quality stocks which are selected based on how well they might do over the long term. Peter Lynch is our poster child. He was asked in early March about the stock market and he said, “I’m the wrong guy to ask because I’m always bullish.” Watch on T.V. and in what you read. If you see a hedge fund or mutual fund manager say that they are bullish on the market and then explain that they are long Oil, Gold and Basic Materials, you are staring a bear in the face!

Warm 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

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

Among our most golden rules for investing is the rule that says to avoid or sell investments which are being most heavily promoted after a lengthy stretch of success. Here are the first few paragraphs of an offering announcement from May 27th on Bloomberg:

Claymore Investments Inc. has raised $400-million for its new gold bullion fund — an amount that could swell to $460-million, making it the largest structured product offering and one of the largest initial public offerings in at least two years.

The fund, which includes a number of novel features, including a hedge against the U. S. dollar, capitalizes on seemingly unquenchable thirst for the metal amid growing concern over inflation and the outlook for the greenback.

Notice in the second paragraph that it “capitalizes on seemingly unquenchable thirst for the metal”. Language like this happens at the top of the market and every single hot market that we have witnessed in the last 29 years seemed unquenchable until it was quenched by massive offerings like this. Isn’t it interesting that oil and gold are right back at the forefront of popularity even though Oil peaked at $147 per barrel one year ago and gold has gone relatively dead now that it doesn’t have Financial Armageddon stirring up investors. We covered oil earlier in the week, so let’s take a shot at gold while we’re in the mood.

Gold was $800 per ounce while I was in college in the late 1970’s. If it was such a good inflation hedge, why have folks who owned it so long lost their purchasing power?

Gold pays no dividends and has no earnings power, so you lose whatever you could have made in a productive investment like common stocks or bonds or CDs (Opportunity Cost). Lastly, the vast majority of demand for gold comes through the acquisition of jewelry. Jewelry sales are down 20-30% this year from last year and it is safe to say that it would be surprising that expensive jewelry would be the first category to bounce back in the new and more frugal environment of the next few years.

We at Smead Capital Management don’t buy the hyper-inflation story. Lending and securitization of loans has been permanently damaged in the recent credit crisis/panic and Americans will establish permanently higher savings rates than the last two decades. Excess capacity in manufacturing and services will persist for years and unemployment will take years to work down from the 9-10% levels. We add it all up and conclude that we want to own the premier companies with the strongest balance sheets, most recognizable brands and the most consistent customer bases. Besides, how can you thirst for a solid anyway?

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

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

Dear Clients and Prospective Clients:

As the first four weeks of a powerful upswing in the stock market unfolds, we thought we would use a few moments of your time to ask a few questions.

1) What if the crowds of professional and individual investors are as wrong at extremes this time as they have been in the past?

2) What if the money in money market funds, CDs, savings accounts and T-bills all tries to come back into stocks at the same time?

3) What if Warren Buffett’s Oct 18, 2008 editorial about “Buy American, I Am” proves to be excellent advice?

4) What if the people who were smart enough to avoid some of the bear market on the way down never get back in on the way back up?

5) What if the fact that stocks dramatically outperform Treasury Bonds over long periods of time reasserts itself quickly?

6) What if buying and holding blue chips stocks works significantly better than trading in and out?

7) What if President Obama is the lucky man who leads our country as it successfully comes back from the worst economic contraction since the 1930’s?

8 ) What if gold, which has been trading exclusively on fear, goes down or nowhere for years?

9) What if everybody stops postponing the work they need to do on their home?

10) What if everyone who needs a new car buys one?

11) What if Starbuck’s coffee continues to be legal, addictive and tastes great?

12) What if the major Pharmaceutical companies sell more drugs in the future in China and India than they sell in the U.S.?

13) What if the people who sat through the worst stock market decline in 70 years are fully invested at the bottom and enjoy years of success because of it?

If you are underinvested in common stocks and/or are not investing with us, it is not too late to buy by any means!

Warm 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

Printable Version
Subscribe to the Missives Podcast
Click here to listen to this Missive

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.