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:

Mike Myers is a very talented writer and comedian. His Austin Powers movies really hit my funny bone. In the second Austin Powers movie, Austin’s arch nemesis Dr. Evil clones himself. His clone looks just like him, but is less than half as tall and attempts to be just as evil on a pound for pound basis. Mini-Me, as his clone is called in the movie, creates strife between Dr. Evil and his son, Scott. Scott was the product of Dr. Evil’s dalliance with Frau Farbissina, a loyal employee who he “got weird” with.

Bespoke Investment Research reported yesterday that Oil has now gone up 108% in price per barrel in 118 calendar days. It is the sixth best bull run in the commodity since 1986. Four of those bull runs occurred in the huge secular move from $11 per barrel in late 1998 to the peak at $147 one year ago. This one and the 164% increase when Saddam Hussein invaded Kuwait in the summer of 1990 are the most violent in the shortest amount of time. The four other 100% plus gains in price lasted a minimum of 453 days to a maximum of 542. The huge run from $11 to $147 per barrel culminated in a Malthusian orgy and sought to validate a theory called “Peak Oil”. This theory held that the un-interrupted growth in emerging economies around the world was coinciding with the peak of worldwide oil production. In effect, Dr. Evil (those countries producing Oil and companies involved in producing it) would hold the rest of the world hostage and demand “Millions” of dollars (he meant billions and trillions) in ransom.

In the minds of Smead Capital Management there were at least four big problems with all the excitement about “Peak Oil”. First, it was predicated on uninterrupted growth in emerging markets and that has already been debunked. Second, high prices and fat profit margins caused over-production as every country or company which could find and produce oil did. Third, and most importantly, it assumes that the largest oil consumption country (U.S.A) will not permanently modify its behavior. We believe that we will move away from gasoline powered transportation producing air pollution, just as we moved away from horse transportation activated by oats and hay (resulting in manure) between 1910 and 1925. Everything moves faster nowadays and the huge economic reset of the last year and the will of the Obama Administration seem to have jumpstarted the process. Lastly, the move from $11 to $147 per barrel culminated in a “bubble”. And “bubble” markets can have bounces, but they don’t get put back together for a minimum of 5 to 7 years from what we read and know of history.

This year’s run from $32 to $72 per barrel looks and acts like last year’s activity, but we think it is a Mini-Me among oil rallies. It is predicated on the idea that emerging economies will lead us out of the worldwide recession. Under that assumption, the use of oil and other commodities would be at the forefront of the economic recovery. Today’s oil bulls think oil is the best place to be because the building of infrastructure, in their minds, will dominate the economic recovery. This compares to U.S. consumers who have permanently reset their spending at lower levels. We think they are wrong. Even though China or India have one billion people their consumers still control a pittance or Mini-Me level of buying power in comparison to the average American. An old and true business adage says, “If nothing is sold, nothing is produced.” Most production is held hostage by retail sales. Just ask any automobile company today and they will reinforce us. If the U.S. economy doesn’t come back, don’t hold your breath waiting for everyone else to get their “Mojo” back.

We believe we are in the midst of what we think is a Mini-Me rally in Oil which is attracting the same kind of hot money that it attracted in the first half of 2008. It would like to hold our economic recovery hostage and hog up investment capital. Don’t believe this rally in Oil. We think it is “catnip for clones”.

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:

We at Smead Capital Management are not afraid to admire people who disagree with us. If someone sincerely believes that the stock market is going to do poorly over the next two years, puts their money where their mouth is and sticks to their guns, we have nothing against them. We don’t agree with them, but we can accept their position. They are Bears on the market and they most likely believe that price earnings ratios didn’t get low enough in March to justify a bottom or they believe that the debt accumulated in the last ten years will stifle economic growth and retard the financial system. They go by names like Roubini, Faber, Tice and Rogers. We have no problem with them and we think that the way they have scared everyone is going to make long-term buy and hold investors like us a ton of money.

However, there is a second kind of Bear in the marketplace and we consider them to be dishonest Bears. They are the hedge fund managers, mutual fund managers and individual investors who temporarily own some stocks, but own them with one foot out the door the entire time. This is the “Fast Money” crowd and they are looking for something to own for six weeks to three months. Jim Cramer is there poster child and the discount brokers and stock exchanges are their sponsors. They are the worst kind of momentum investors. We consider them bears because the way they are organized and postured makes for very little likelihood that they or their clients would gain the benefits from holding common stocks for many years. After all, over long stretches of time a significant part of what you make from owning common stocks comes from dividends. In affect they rent stocks rather than own them. They whip around ETFs, are attracted to momentum markets like Gold and Oil and love high levels of volatility. Included in this category are the hyper-inflation folks who are invested in commodity oriented common stocks and think they are going to make a great deal of money from an economic comeback that ruins everything with high levels of inflation like in the late 1970’s and early 1980’s.

We normally wouldn’t really care about these “Closet Bears”. Unfortunately, in this market cycle, they have ended up with way more of the existing capital than normal. It makes sense because after the decline from October of 2007 to March of 2009 most humans who have the courage to participate want to get out of the way quickly if things turn sour again. So you have the “Real Bears” who are in cash and short stocks, mortified from what happened this year. Then you have the “Closet Bears” long stocks for two months at a time with one foot out the door all along.

To be a “Real Bull” you have to be fully invested in quality stocks which are selected based on how well they might do over the long term. Peter Lynch is our poster child. He was asked in early March about the stock market and he said, “I’m the wrong guy to ask because I’m always bullish.” Watch on T.V. and in what you read. If you see a hedge fund or mutual fund manager say that they are bullish on the market and then explain that they are long Oil, Gold and Basic Materials, you are staring a bear in the face!

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.

William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Clients and Prospective Clients:

Among our most golden rules for investing is the rule that says to avoid or sell investments which are being most heavily promoted after a lengthy stretch of success. Here are the first few paragraphs of an offering announcement from May 27th on Bloomberg:

Claymore Investments Inc. has raised $400-million for its new gold bullion fund — an amount that could swell to $460-million, making it the largest structured product offering and one of the largest initial public offerings in at least two years.

The fund, which includes a number of novel features, including a hedge against the U. S. dollar, capitalizes on seemingly unquenchable thirst for the metal amid growing concern over inflation and the outlook for the greenback.

Notice in the second paragraph that it “capitalizes on seemingly unquenchable thirst for the metal”. Language like this happens at the top of the market and every single hot market that we have witnessed in the last 29 years seemed unquenchable until it was quenched by massive offerings like this. Isn’t it interesting that oil and gold are right back at the forefront of popularity even though Oil peaked at $147 per barrel one year ago and gold has gone relatively dead now that it doesn’t have Financial Armageddon stirring up investors. We covered oil earlier in the week, so let’s take a shot at gold while we’re in the mood.

Gold was $800 per ounce while I was in college in the late 1970’s. If it was such a good inflation hedge, why have folks who owned it so long lost their purchasing power?

Gold pays no dividends and has no earnings power, so you lose whatever you could have made in a productive investment like common stocks or bonds or CDs (Opportunity Cost). Lastly, the vast majority of demand for gold comes through the acquisition of jewelry. Jewelry sales are down 20-30% this year from last year and it is safe to say that it would be surprising that expensive jewelry would be the first category to bounce back in the new and more frugal environment of the next few years.

We at Smead Capital Management don’t buy the hyper-inflation story. Lending and securitization of loans has been permanently damaged in the recent credit crisis/panic and Americans will establish permanently higher savings rates than the last two decades. Excess capacity in manufacturing and services will persist for years and unemployment will take years to work down from the 9-10% levels. We add it all up and conclude that we want to own the premier companies with the strongest balance sheets, most recognizable brands and the most consistent customer bases. Besides, how can you thirst for a solid anyway?

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:

The biggest pollution problem in the United States in 1900 was urban horse manure. Horses need to eat. According to one estimate each urban horse probably consumed on the order of 1.4 tons of oats and 2.4 tons of hay per year. This also means that a great deal of those tons of oats and hay were converted to manure. The estimates are that horses disposed of between 15 – 30 pounds of manure a day. Eighty-six percent of local transportation was by horse and buggy. Remember, there were only 4100 automobiles sold in the U.S. in 1900. Automobiles were even named after horse drawn buggy’s, a “carriage” or “car” for short!

Technology solved the urban horse manure pollution problem. By 1925 Americans had purchased 3.7 million cars in a single year and by 1929 there were 26.5 million autos in use in the U.S. How do you think the price of horse drawn carriages, oats and hay did from 1900 to 1930? I ask this question for a simple reason. Why do many of the “experts” and many of the portfolio managers that I admire invest heavily in the idea that a limited supply of Oil and Gas will result in higher prices? And why are they so excited about the companies who make a living supplying drilling equipment and oil rigs to the oil and gas industry?

Our popular new President, Barack Obama, has laid out ambitious goals for gas mileage and even Bill O’Reilly thinks they are a good idea! The only way that those goals can be reached is by dramatically increasing the number of hybrid and electric-only vehicles in use. Today’s number one polluter in major cities in America is the gasoline fueled internal combustion engine. When the sun shines for a week straight in Seattle (yes, that actually happens a few times each year), a brown haze engulfs the low horizon. In cities like Beijing, you can barely see in the distance.

The only bear market rally going on in Wall Street today is the rally in the share price of oil and gas related companies. At Smead Capital Management we believe technology will eviscerate a great deal of demand for oil in the next ten years, just as it did for oats and hay just after 1900. We are happy to be under-represented in oil and gas companies, but are looking for investments in electricity that meet our strict criteria. And that is no manure.

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.