William Smead
Chief Executive Officer
Chief Investment Officer

 
Dear Clients and Prospective Clients:

In his book, Day by Day, Reverend Billy Graham wrote the following: “Columbus was called mad because he decided to sail the uncharted ocean….Martin Luther was called mad because he presumed to defy the entrenched religious hierarchy of his time. Patrick Henry was considered mad when he cried, ‘Give me liberty, or give me death!’ George Washington was thought to be mad when he decided to continue the war after the winter at Valley Forge, when thousands of his men had died and other thousands had deserted, leaving only a handful of men. We have become too sophisticated and too respectable to be called mad in our generation.”

Every twenty to thirty-year stretch in the stock market includes a multiple-year sequence where it seems like those of us who stay invested in quality common stocks have gone mad. Numerous studies have come to the same conclusion over and over again. Human beings sell their stocks after big declines and buy aggressively near stock market tops. In the process, they rob themselves of a large part of the benefit of owning common stocks. Ibbotson measured the return from 1926 through 2007 at around a 10% return including dividends on the S&P 500 Index. Numerous studies show that investor enthusiasm in the form of mutual fund purchases at the top and investor pessimism in the form of mutual fund redemptions at the bottom caused those investors to dramatically underperform the long-term results of the funds they owned.

Is an investor more likely or less likely to make the historical return of 10% from here forward? We believe the math, the history and the crowd psychology all say that it’s more likely. Do we know what we have to put up with to get it? The answer is no. Much capital has been temporarily lost while many investors have deserted the stock market and are sitting on a record amount of cash relative to total stock market capitalization.

Warren Buffett is the greatest investor of all time and many articles are being written about him. They infer that he has gone mad to be buying into strong companies and is recommending others buy as well during this tough economic period (”Buy American, I Did”, New York Times Op-Ed October 16, 2008). We at Smead Capital Management believe that we have never owned more attractive companies at better prices than today.

We must have gone mad!

Best Wishes,

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

2. We believe we are in the third and hopefully final phase of liquidation in the worst financial panic, credit crisis and business coma that we have seen since the 1930’s. The first phase of liquidation was tied to sub-prime mortgages and the financial institutions that got caught up in them. The second phase of liquidation was the de-leveraging of hedge funds, private equity funds and businesses and investors who were counter parties to failed institutions like Lehman Holdings, AIG and WAMU. The third phase, which we are in right now, is the liquidation by stock market participants (primarily mutual funds and other institutional investors) of company shares due to concerns that the temporary business coma could become a two-year coma.

3. We believe that the strength of our company’s balance sheets and the elimination of their existing and potential competitors by the business coma will cause them to not only be survivors, but to prosper. Sprint is crippled in comparison to AT&T and Verizon. Disney’s theme parks, Movie division and Cable Network gain market share from less well financed industry foes. New drug companies aren’t getting funded while Merck, Pfizer, Abbott Labs and Amgen sit on billions of cash, are gushing free cash flow and fund incredible research. WalMart and Nordstrom’s are seeing major competitors declare Chapter 11 bankruptcy. JP Morgan, Wells Fargo and the Bank of New York/Mellon appear to be the cream of the remaining banks.

4. We believe that we under-estimated the severity and length of this liquidation and over-estimated the attractiveness of our necessity businesses and how well their balance sheet strength and dividend payments would defend our capital.

5. We believe that the bull market that follows this bear market will be ten to fifteen years long and will repay those of us that make it through this current financial misery many times over. However, we don’t know how soon the “Next Great U.S. Stock Market” will begin or what the magnitude of any additional liquidation will be.

We sincerely appreciate you considering our thoughts,

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

Many companies we don’t own, like Apple and American Express, reported their earnings yesterday. Apple fell sharply in the after-hours trading market even though earnings grew 31% and American Express admitted significant additional credit reserves and potential loan losses and it negatively affected investor attitudes among many major financial company share prices yesterday afternoon. Google made a 35% gain in earnings for the most recent quarter and fell 10% since last week.

My conclusion is to maintain confidence in the discipline and wherever possible use the current weakness to upgrade the quality of what we own. We did that last week when we exchanged a stock we think has a good future, Legg Mason, for two higher quality companies which have similarly bright futures but carry less risk, Franklin Resources and Bank of NY/Mellon. We did the same thing when we traded Wachovia for JP Morgan in the last couple of months. My years of experience have taught me that pain in the stock market leads to wealth; and glory in the stock market leads to pain. You can imagine where I think we are now. Thank you for your patience and trust.

William Smead