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

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