William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Clients and Prospective Clients:

At the start of the year, we at Smead Capital Management predicted that 2009 would be like 1988. In the aftermath of the 1987 Stock Market Crash the market thrashed around violently in both directions before settling at the end of the year with about a 10% gain counting dividends. People had to put up with a great deal of volatility to earn that gain in 1988 and we felt that 2009 would look similar. We are halfway through the year and 2009 appears to be 1988 on steroids. The down swings and upswings have already been huge, but the stock market is about where it started the year.

We also have felt that the economy would begin to grow again once we got past the massive “reset” in consumer spending which started in September and October of 2008. Spending figures are typically measured against the prior year. We have continued to believe the year over year retail sales comparisons will be positive in the fourth quarter of this year as compared to the economic coma figures of late 2008. The stock market is an anticipatory vehicle and we expected that the market’s rally would begin six to nine months before the economy improved. It did in fact bottom around March 9th or six to seven months before the consumer spending reset turned one year old.

There have been some big surprises for us this year and those surprises are a big part of the market’s recent pullback. We believe that the economic “reset” is going to become the kickoff of an era of slower growth and unwillingness on the part of the average consumer to take on debt. In this slow and consistent era we expect a substantial premium to be placed on the companies which perform well despite the new environment and borrowing reluctance. In the prior era, investors basked in the belief that the growth in emerging market countries like Brazil, Russia, India and China would drive worldwide growth, thus placing a premium on the production and distribution of natural resources like oil, basic materials and fertilizer. These cyclical industries out-performed the market from 2004-2008, got clobbered from the second half of 2008 into the new year and came roaring back in the rally off of the March bottom.

If we are right and investors resign themselves at some point to the new environment, the normal premium for strong balance sheets, brand recognition and consistency of customer base should be reestablished. This means lower P/E ratios for cyclical businesses and higher P/E ratios for companies that meet our strict 8 criteria. What normally is highly valued by investors will take its usual place in the hierarchy of common stocks. We believe this current correction in the market is the beginning of a flow of money away from investor attempts to revive the BRIC trade. We expect to move toward a premium for large quality blue chip companies with relatively non-cyclical businesses. We wait patiently.

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.

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

You’ll notice that we “cried” mostly negative opinions since 1998. However, beginning in a missive we sent on January 18th, we began to alert you to the “Next Great U.S. Stock Market”. The next bull market in U.S. stocks could be the most explosive to the upside that we have ever seen. More cash is on the sidelines than anytime since 1982 and it is being paid the lowest interest rate on Treasuries for 50 years. Stocks are the cheapest they’ve been in over twenty years. Warren Buffett is spending $3 to $5 billion each week on companies like Goldman Sachs and General Electric in an effort to overtake Bill Gates as the world’s richest man. Even my well-trained clients are calling me daily asking if they should bail out instead of doing what Buffett is doing and buy, buy, buy. Lastly, everyone was looking for capitulation in the market and we got it this week. We believe the “Next Great U.S. Stock Market” is on the way and our prediction is that the first leg of the next bull market will be the best first leg of my lifetime. And that is no fairy tale!

Warmest regards,

William Smead

Tony Scherrer, CFA
Senior Vice President
Portfolio Manager 

Market extremes always seem to last far longer than participants realize at the time, and this one has been no different. While this outlasting effect has caused us our share of short-term grief, we also know that it is exactly this type of thinking that causes us and our clients to benefit by what the market brings next, and that this price of admission is what gets you in the door.While we heard no audible bell ring, we believe July 15th marked a significant change in sentiment throughout the capital markets that is worth mentioning. We would not be surprised if we are now in the early stages of the next bull US stock market.

The below table shows the performance of the S&P 500, along with the top S&P 500 sectors, and their performance over two time periods: the beginning of the year until July 14th, and mid-July until mid-August. (Sorted by mid-July until mid-August price change) Notice the stark contrast: the sector performance is almost exactly inversely related over the two time periods.

Beyond the domestic stock market, since mid July, the US Dollar Index has sharply rallied, oil has cracked significantly (along with most other commodities), and international and emerging stock markets have materially underperformed the US. These are all things we have been expecting for some time now, and it seems our thesis is beginning to play itself out.

This major shift is also among the last things on the minds of your average market pundit or talking head (i.e., CNBC). Indeed, it seems consensus rhetoric remains bullish on the BRIC trade (Brazil / Russia / India / China), which includes commodities and basic materials (the fuel used to thrust those economies forward). And it seems this trade has been well played out among average investors.

The Investment Company Institute tracks mutual fund flows on a monthly basis. The 12-month ended May 2008 numbers were striking:

Type of Fund Net inflow / (outflow)

U.S. Stock ($80.4 billion)

International Stock $75.7 billion

Bond $111.1 billion

Money Market $975.7 billion

Source: ICI, Figures run from June 2007 to May 2008

Jesse Livermore, one of the world’s greatest traders, once said “the market is designed to fool most of the people most of the time.” We believe we’re on the right side of the trade, and we feel that trade is now in place. The cash buildup among investors is at historically high levels, and as the market readjusts to a new reality over time, this will be the fuel used to create what we believe will be the next great US stock market.

Thank you for your continued confidence,

Tony Scherrer, CFA