William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

Heart disease has been prevalent in our family. About three months ago we started to develop better eating habits. We are trying to avoid many of my favorite foods (chocolates, hamburgers, fries, pizza, etc.) by replacing them with fruits and vegetables. We are bringing down our cholesterol in the process and a positive side affect is that I’ve lost some weight as well.

As Frank the Tank said in the movie, Old School, “It tastes so good when it hits your lips”. I miss the wonderful flavors of dark chocolate Mounds bars or the blending of the tastes in a cheeseburger with a big slice of Walla Walla sweet onions. They give me a big boost of energy, but years of eating these favorites can layer my arteries in plaque. This is the main cause of heart attacks and strokes.

It is amazing how similar long duration investing is to long duration living. At any given time, there are tasty and exciting industries, sectors and countries which can give you short-term delight. Imagine the pleasure of folks who bought gold three years ago or commodities like copper or cotton or sugar. This burst of price appreciation has raised investor confidence the way my blood sugar level goes up right after Thanksgiving Day dinner! The benefits are in the short run and the problems come much farther down the road.

Investors were excited about gold in 1980 when I started in the investment business. It peaked above $700 per ounce in 1981 as investors were sure that the double-digit inflation would be a fixture of the future. Today, investors are excited about it at $1400 per ounce as an alternative to paper currencies. These currencies have multiplied in the deep recession through the remedies governments are using to prevent deflation. Gold has doubled in price in 29 years. This means that despite all of the recent excitement you have received about a 2.5 percent average annual return during those years, even though it has been on fire for five to seven years. The Dow Jones Industrial Average rose from 800 to over 11,000 in that same time period. Those who used gold as a long duration investment had hardening of their financial arteries.

How about commodities like copper, cotton and sugar? The most widely followed commodity indexes, like the Dow Jones-AIG Commodity Index, show that commodities have dropped in price on an inflation adjusted basis fairly significantly over the last 70 years (see chart below). Therefore, their only use is for the kind of short-term highs that I get from the fresh cooked chocolate chip cookies or the barbecued ribs lathered in sweet sauce. Better technology and human productivity are a curse to commodity investing! Compare that to all the wealth creation which long duration companies like Disney or McDonald’s or Nordstrom or Merck produce from those same factors. As an investor, do you want better technology and human productivity to be your friend or your foe?The current investment landscape is loaded with sugar highs. All things China and BRIC trade are smoking hot including the commodities we’ve mentioned. The blood sugar level has taken heavy industrial stocks like Caterpillar, Joy Global and Cummins off the charts. The taste of mining basic materials in Australia and putting them on a boat to China is mouth watering. The GDP growth numbers in China are as exhilarating as drinking a couple of craft beers while washing down hot wings.

Our bodies are subject to heart disease and those events usually come in shocking fashion. In the investment world there are business cycles with recessions and depressions mixed into history. When these negative events follow a boom, markets collapse and can lead to paralysis and permanent damage. Cyclical and commodity oriented common stocks trade at historical discounts for this very reason. Our current circumstance is that cyclical stocks and more economically sensitive small cap stocks trade at big premiums to recession resistant large cap non-cyclicals! History shows that investors in the cyclical stocks get crushed and profits many times turn to losses in the down cycles. Holding for the long-term is not an option which human investors have been able to handle.

As disciplined long-term value investors, we at Smead Capital Management are patiently waiting for time to put things back into order. We believe long term financial health goes to those who defy short-term flavor gratification. Much like the fable of the Tortoise and the Hare, you only make the long-term success in investing if you avoid the busts that follow the adrenaline of today’s excitement. We wish you all health and wealth in the upcoming New Year!

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:

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

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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

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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

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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.