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:

The darkest days in World War Two were during the bombing of London. Air raid signals would blare and folks would go underground and wait for the bombing to get over. Since the United States had not yet entered the fight and mainland Europe had been overrun by the Germans, the British were left to stand alone. The relentlessness of the pounding and the loneliness could have broken the spirits of the British. With the strong leadership of Winston Churchill and their own grit and courage, they held on. The Pearl Harbor attack of Dec. 7 of 1941 brought the U.S. into the War and also initiated the process which led to an Allied victory.

For investors in U.S. common stocks, the year 2008 will go down as a year of unrelenting declines. We investors feel bombed out and many of us have sought shelter in Treasury securities, CD’s and money market funds. Today’s early trading fits the pattern we’ve seen all year. Stocks are down across the board without any discrimination between companies or sectors which might fare the best going forward. It is indiscriminate bombing and very disheartening and lonely.

Much like the British did, we must display courage and grit as long-term investors. The deep, long-lasting recession, which the experts have predicted since November of 2007, is trying to convince us to give up hope, just like the prospect of a long war tried to convince the Brits. We have to withstand overnight bombings as Hedge Funds redemptions, Mutual Fund liquidations and Margin calls force across the board selling without regard for future prospects.

In World War Two, the reward for not giving up was the defeat of an evil Dictator and an out of control regime called Nazi Germany. Financial matters are not nearly as important, but from these depressed prices on common stocks, significantly lower commodity prices, low interest rates and high levels of human ingenuity, we at Smead Capital Management believe a great deal of wealth could be created by owning U.S. common stocks over the next five to ten years. We intend to pursue victory with a portfolio that can withstand whatever bombings that remain and can prosper in the good years to follow.

Best Wishes in this Holiday Season,

William Smead

Almost two years ago, the Arizona Republic did a feature story on their cover about a talented and successful residential real estate agent located in Paradise Valley, Arizona. He was featured because the Phoenix market had been hot for years and nobody was hotter selling high-end homes than him. Phoenix and its high-end homes were pre-ordained to fall and boy have they fallen.

Pull out yesterday’s Sunday business section of the Seattle Times and you’ll see a feature on shortsellers. It’s the kind of article they write when someone has been on a roll (in this case betting against stocks). Short Sellers have every right to bet against stocks, but the media only wants to write about you when you’ve had a hot hand lately. There were no features on short sellers in the 1990’s, as stock rose dramatically off and on for a decade.

These cover stories come from the media all the time, both nationally and locally. Examples include T. Boone Pickens, Donald Trump and Shawn Alexander (the former Seahawks running back). The media had Boone Pickens all over their covers during the big run up in Oil prices. The price of oil has since been chopped in half and Picken’s Hedge Fund has lost $2 billion.

When real estate was hot, the “Donald” and his smiling face were everywhere. Sell real estate when Donald Trump is popular and buy when he is in bankruptcy court. Former Seahawks running back, Shawn Alexander graced the cover of Sports Illustrated two plus years ago (after being named league MVP). He couldn’t find a team that would hire him at the start of this year. The Seahawks can barely win a football game. The fall from the cover is a hard one.

The media is in love with the Hedge Fund managers and shortsellers who have had the hot hand in the decline of the last few years. We think they and their investors could be singing the blues in two years. Remind me to be cautious down the road when the cover stories are about value buyers like us, who stayed the course around the bottom of the Panic of 2008. We are looking forward to getting to the top of the performance mountain from this difficult valley and believe that it is being set up by the current cover stories.

Best Wishes,


William Smead

William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

Stocks

As we saw from June 30th to now in the price of Oil, price is a great regulator of price. Stocks are way down, having dropped the most in October since the crash of 1987. An abundance of selling supply coming from hedge fund liquidations, margin calls, mutual fund redemptions and individual stock owners (reaching their pain threshold) has overwhelmed the few lonely buyers. Most of the selling is being done in panic. The lonely buyers are people like corporate insiders and value-oriented, patient investors like Warren Buffett, John Neff, Marty Whitman and us at Smead Capital Management. Supply is high, demand is nil and prices are low.

Treasury Bonds

Demand is the highest since the 1930’s as investors want U.S. Government assurance of payment of principle and interest. Sellers are lonely and prices are high. Watch out though, because the Federal Reserve and Treasury are looking to massively increase supply as they trade Treasuries at high prices for preferred stock in depressed banks and out-of-favor mortgage loans.

Real Estate

Lonely buyers are coming out of the woodwork at lower prices to snatch up bargains in California, Nevada, Arizona and Florida on short sales and foreclosures in an ocean of supply. This bubble, which broke at the end of 2005, is now being bottomed as the media misses the law of supply and demand. The media rails about huge drops in housing permits, starts and sales. These are a big supply reducer and leaves buyers shopping among the existing supply.

Corporate and Municipal Bonds

Investors are so scared that they don’t trust state and municipalities. Lonely buyers are seeing the biggest spreads to treasury bonds since the 1930’s and supply is contracting fast.

Money markets/Cash/T-bills

These are the world’s most popular investments. There are hardly any lonely sellers and there is currently the world’s biggest army of buyers. Money-market prices are at record highs and interest rates at or near 70-years lows.

Commodities

This asset class was hotter than a pistol from 2003 to four months ago. However, price regulates price and that rule is no exception in the price of oil, grains, basic materials and other commodities. Supply comes out of the woodwork and alternatives become very attractive. I would expect this asset class to be dead money in the “Next Great U.S. Stock Market.”

I remember being a lonely seller of Tech stocks in late 1999 and feeling incredibly foolish as I talked to unhappy clients who were watching their rabid neighbors get wealthy overnight on the latest Initial Public Offering (IPO) of common stock. Supply was exploding and buying was frenzied. We are at the exact opposite today. Sellers are dumping the best companies with the brightest futures and there are virtually no IPO’s. As the “Motels” sang in 1982, “It’s like I told you, only the lonely can play.”

William Smead

Investors are divorcing their stocks. Here is the list of reasons they seek to dissolve their relationship with America’s best companies.

1. We are in a deep recession which could last one to two years. Most knowledgeable economists believe that since last December that our economic slowdown has had the characteristics of a recession. If it is deep (a 3 to 4% decline in economic activity) it will last another year. The stock market discounts the future 9 to 12 months out and has historically bottomed in the middle of a recession. In a deep recession, 97% of all the economic activity that went on the previous year happens. Would you divorce your spouse if he/she loved you 3% less for one year and then his/her love started growing almost uninterrupted in future years?
2. The Treasury Rescue Plan is not working. Most of the plan has not even begun to operate. No commercial paper loans, preferred stock investments in banks or auction buys of out-of-favor mortgage-backed securities have been purchased. Would you divorce your spouse just as you entered marriage counseling?
3. Hedge funds and wealthy executives owning stock on margin are being forced to sell. Do you divorce your spouse because the neighbors got a divorce or because a relative decides to call it quits? Hedge funds used huge leverage to create a fantasy that they deserved the assets of the wealthy. They are selling what they can (blue-chip stocks) to meet margin calls from the banks. Many executives have used borrowed money to expand their ownership of their own company or make additional outside investments and as shares have dropped, they are forced to sell. As the public sees the huge declines in the market and the temporary/violent declines in their 401k’s or personally owned mutual funds, they are redeeming their shares. This forces a portfolio manager who prefers to buy his/her favorite stocks to sell the very companies that they prefer to buy. We buy stocks with cash and therefore don’t run into these margin call pitfalls. MAJOR MARKET BOTTOMS COME WHEN THE SELLERS ARE INDIVIDUALS OR INSTITUTIONS WHICH PREFER TO BE BUYING, BUT ARE FORCED TO SELL AND ULTIMATELY THERE ENDS UP BEING NOBODY LEFT TO SELL!
4. We are never going to buy things or pay for services from each other any more. If that is true you don’t need a big cash position from divorcing your stocks, you need a big gun and ammunition position. In the “Great Depression”, quality blue-chip stocks did as good a job of maintaining your purchasing power from beginning to end as most any other place folks kept money. So divorce didn’t even make sense in 1930 or 1931 when investors had already been abused as much as we have been in the last 12 months.

Despite what we might have to go through in the next few weeks and months, we would like to marry as many of our favorite companies and hold onto the ones we have. We believe this might be the best entry point into the U.S. Stock Market in 50 years.

Warmest regards,

William Smead