William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Fellow Investors:

On Wall Street there are a number of old adages and one of the all-time favorites is the trend is your friend. In this week’s missive, we at Smead Capital Management would like to talk about trends that exist in today’s market. In the process, we will try to determine if they truly are the investor’s friend.

We are contrarians and look for extremes of psychology primarily to attempt to spot trend changes early. The biggest trend which exists today is the secular decline of US Treasury interest rates over the last 29 years and the bull market that has occurred in the bond market as a result of those lower rates. In 1981, the ten-year Treasury Bond peaked at an interest rate of over 15%. Today it is just below 4% and bottomed out below 3% in the panic and stock market meltdown of the fall of 2008 and the winter of 2009. Many highly respected experts are predicting that interest rates could rise to 6% on ten-year Treasury Bonds in the next couple of years. The avalanche of money which flooded into the bond market from the middle of 2008 right up to today is an indication that this secular trend could be changing. The only caveat we have is that overall borrowing in the US should drop to lower levels in the next ten years as we work off the leverage of the prior ten-year borrowing binge. Our vote is that the long-term secular trend of declining Treasury interest rates is not your friend.

Since the year 2000, bull markets in emerging market stocks and commodities which benefit from the above-average GDP growth, has been a major trend. We believe that the maintenance of this trend is dependent on un-interrupted growth in China. We are biased toward the contrary thinking of Jim Chanos on this subject. Since commodities and emerging markets have been the best place to be for ten years and China is due for a stumble, we don’t think this trend is your friend.

Starbucks is a coffee/restaurant company which has prided itself on being hip, cool and on the cutting edge. Starbucks has had a tendency to be a corporate game changer. They recently declared their first dividend of $.10 per quarter. Non-financial public companies are sitting on record setting amounts of cash on their balance sheets and are generating very high levels of free cash flow due to cost cutting. As sales and earnings rebound, look for other companies, which either pay no dividend or a low percentage of after-tax profits, to pay or raise their dividend. Not only does this make good sense for shareholders, but it makes great sense for top executives who would like to get paid more for their efforts. If the board raises your salary or pays you a bonus, the media and populist politicians are going to be all over you like a blanket. If you pay a dividend or raise the dividend and you own a big slug of your common stock, you get a sizable pay increase without criticism. Howard Schultz got a huge annual income increase from the Starbucks dividend and I haven’t seen one media article of condemnation or a populist politician offer a comment. We own a number of companies in this situation like Ebay, Amgen and Microsoft. We think this is a new trend and for the long-term investor, it could definitely be your friend.

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

Dear Clients and Prospective Clients:

There is an amazing fact in investment analysis. The longer you are right, the greater the amount of intelligence people attribute to you. Along those same lines the more money you make in business, the more intelligent people think you are. It’s like the investment world is perpetually playing the board game LIFE. In the game, if you are lucky enough to get the right roll at the beginning, you become a Doctor. The medical profession had the highest income in the game and made you more likely to win. The game was invented in the 1960’s, when Doctors were the highest paid professionals in town and were also the most educated. Since they had the highest incomes and most years in school, people asked for their opinion on a broad array of subjects under the assumption that their personal success and academic education made their opinion more valuable.
 
At extremes in markets there has usually been someone of stature who felt early on that what has happened would happen. The longer that the trend continued and the longer that the person of stature continued to predict its continuation, the more intelligence investors attached to them. A few historical examples are in order. In the very high interest days of the early 1980’s two economists, Dr. Henry Kaufman and Dr. Albert Wojinalower, correctly predicted that the Federal Reserve and its leader Paul Volcker would tighten credit and raise interest rates high enough to break the back of inflation. They were called Dr. Doom and Dr. Death because of their bearish views on the bond market and the economy. Unfortunately for them (at the time that they were considered the most intelligent form their correct predictions) they were predicting 22 to 25% Prime interest rates at the peak in 1981 and told everyone to stay out of bonds at the single best time to buy them in U.S. history !
 
Mary Meeker and Henry Blodget were technology stock analysts in the late 1990’s and rode the dot-com bubble for everything it was worth. Once again they were idolized and ascribed great intelligence until the bubble burst and they stayed bullish a long way into the crash. They crushed their fan club in the process. More recently, the oil analysts at Goldman Sach’s were riding high from predicting in 2005 that oil would climb immensely in the coming years. They predicted $90 per barrel oil and ratcheted that prediction up as oil exceeded that target in 2007 and 2008. When oil reached $145 per barrel, they were considered total geniuses and flatly predicted a run as high as $200. I haven’t heard a word about them lately as oil is below $50.
 
Today, a banking analyst at Oppenheimer by the name of Meredith Whitney and a New York University Professor by the name of Nouriel Roubini, who correctly predicted much of the difficulty experienced in the banking and financial companies the last two years, move the markets every time they appear on CNBC or Bloomberg. Their intelligence meter is through the roof and the respect the markets pay them matches it. We at SCM assume that they will be singing the same tune all the way through the bottoming process and could be scaring investors away from financial companies at the bottom the same way that Henry Kaufman and Albert Wojinalower did with bonds in 1981! Remember, the longer a trend is in place the more risky it is to bet that it will continue and all of us are human, even the experts you see and hear on television.

Best Wishes in this Holiday Season,

William Smead