William Smead
Chief Executive Officer
Chief Investment Officer

Printable Version

Dear Fellow Investors:

A number of years ago we wrote a piece about two very similar State of the Union speeches. Calvin Coolidge gave his last State of the Union address in December of 1928 and President William Clinton gave his last one in early 2000. Our country was at peace, had enjoyed an amazing run of prosperity, sat on booming stock markets and the US government had its financial house in order in both cases. These speeches represented inflection points of legendary magnitude. These were the worst two times to invest in common stocks in the last 100 years. What were the odds of that happening?

At Smead Capital Management (SCM), we see a great deal of consternation in the marketplace about the opposite circumstances we see today. The US government and many individual states are running huge budget deficits. We are fighting a worldwide war on terrorism and a number of hotspots are flaring up all over the world. The economy has suffered the deepest recession since 1981-82 and the biggest financial panic since the 1930’s. Lastly, the US stock market is 30% below where it was at the time of President Clinton’s speech after more than ten years. The only decade worse? You guessed it, the one following Coolidge’s speech in 1928.

What are the odds that this is a good time to invest in the US stock market for the next ten years? At SCM, we think high! Tough times impose a discipline on consumers, financial institutions, governments, companies and politicians which lay the groundwork for years of future success. It is exactly the opposite of the sloppy, unethical and undisciplined participants who dominated the markets after years of prosperity and booming stock prices.

Most market commentators were talking about stocks rising to the sky and the elimination of business cycles in the late 1920’s and the late 1990’s. Today, all we hear about is how much hell we have to pay for the sins of the past 10 years. Some call it the “New Normal”. Any number of respected market pundits will tell you how low we have to go to make things right in stocks. Let SCM make an optimistic prediction for you based on today’s negative psychology and seemingly endless list of unsolvable problems. We believe the S&P 500 Index will hit 2000 in ten years and the Dow will hit 20000. What are the odds that the stock market will appreciate 7% per year for the next ten years to accomplish those numbers? We believe way above normal because of how scarce that opinion is.

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

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Dear Fellow Investors:

The current circumstances in the U.S. stock market remind me of one of my favorite bands from college, Supertramp, and their song “Nothing But a Dreamer”. It appears that individual investors and many of the financial advisors that take care of them “have their head in their hands, oh no!” This was pointed out to us in one of Mark Hulbert’s columns in the New York Times on Nov. 8th and in a piece put out on Nov. 12th by Hays Advisory’s Mark Dodson.

Mark Hulbert’s column explained that the lack of buying interest (in fact recent net selling) of U.S. equity mutual funds and Exchange-Traded Funds could be useful as a short-term contrarian indicator, but is disconcerting from the standpoint of his long-term view of the market. His research, assisted by Ned Davis’s research, concludes that this bull market must see net inflows into equity funds and ETFs at some point to be anything more than the bounce-back rally from the steep decline of October 2007 to March of 2009. The research showed that the stock market generally performs better after inflows into equity funds.

In his missive, Mark Dodson calls stocks “Public Enemy No. 1”. His charts show that we had fund flows in October (bond flows compared to stock flows) similar to the bear market lows of 2002-03. Combined with the continued steepness of the yield curve, his research shows that any little pullback in the stock market sends many investors scurrying for the exits because “now they’ve got their head in their hands, oh no!”

How will this contradiction get resolved? Will individuals not get any confidence back in common stock ownership for five to ten years? Will the yield curve stay steep and rates stay incredibly low for an extended period of anemic economic growth (the “New Normal”)? Is this the biggest and best bear market rally in history or was March a historic low that could hold for the rest of my career?

We at Smead Capital Management could be called “Dreamers”, but we like to stack the probabilities heavily in our favor as we dream. Here is a list of some of our observations that lead us to be very excited about owning our portfolio of large cap quality U.S. common stocks:

1) Amazingly good negative psychology to create a continued “Wall of Worry”
2) Discounted price-to-earnings ratios on large cap stocks
3) Hardly anyone talking or writing about a three to five-year bull market
4) Crowded trades in Oil, Gold, Emerging Markets, Commodities, Treasuries, CDs, etc.
5) Negligible investor zeal for common stocks
6) Near universal negative brainwashing among the most popular experts in 24-hour news and internet outlets
7) Massive cash sitting on corporation balance sheets
8) Companies are buying companies (Berkshire bought Burlington, Hewlett Packard buying 3COM, Stanley Works buying Black and Decker)

This Bull Market has gone up 60% from its low of March 2009 with little or no support from net inflows into equity funds and ETFs. What might happen if those flows kick in at some point is a multi-year Bull Market similar to the ones which followed past “deep recessions”. As Supertramp said in the song, “You know, – Well you know you had it comin’ to you”.

We’d like to think that patient common stockholders do have it coming to them.

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.