William Smead
Chief Executive Officer
Chief Investment Officer

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Dear Clients and Prospective Clients:

When a market has been strong, there is no limit to the number of people who will tell you how good it is going to be for the foreseeable future. When a market has gone down for a long time, a multitude will tell you how far down it is going and how long the downtrend will last.

At Smead Capital Management we have developed a term for this that we call a “Well-Known Fact”. By definition (Smead Unabridged Dictionary), a “Well-Known Fact” is a body of economic information which is known by all market participants and has been acted upon by nearly everyone who could care or has the financial wherewithal to care to act. It is best understood through the comments of former Intel CEO, Andy Grove, who said that the best advice he ever got in business came from a professor at the City College of New York. The professor said, “When everyone knows that something is so, nobody knows nothin’.” By nothin’ the professor infers nothing that could do you any good. When everyone believes a fact and has acted on it to an extreme, nothing good can come to you from believing it from an investment standpoint.

Here is a series of “Well-Known Facts” from recent history. Also noted are the assets that were purchased to act on the fact and the end result of the extreme:

Fact 1: The Internet will change our lives. — Asset Purchased: Tech Stocks — Result: From the peak of early 2000, tech stocks fell 80% in 2.5 years.

Fact 2: Residential Real Estate only goes up. — Asset Purchased: Homes in sunshine states of Arizona, Florida, Nevada and California. — Result: 40-50% price drops and a majority of the nation’s foreclosures.

Fact 3: Brazil, Russia, India and China (BRIC) will grow faster than the industrialized world. — Assets Purchased: Commodities and Emerging Market Mutual Funds. — Result: Commodities drop 60-80% and Emerging Markets fall 50-70%.

At the extreme, whatever value that is connected to the assets involved with the “well-known fact” doesn’t matter in either direction and there is no shortage of both expert and non-expert opinion on how high or low the asset prices will go. Henry Blodgett saw the moon for Qualcomm and internet stocks in 1999. No shortage of cable shows taught you to “Flip this House” in 2005. And in 2008, Goldman Sachs’ Oil analyst put a $200-250 price possibility on a barrel of oil. Not to mention T. Boone Pickens, who has been attempting to talk oil prices up since it peaked at $147 per barrel last year.

In the opinion of SCM, here is the new “Well-Known Fact”.

Fact 4: The massive amount of borrowing attached to homes and personal finances in the U.S. over the last ten years dooms us to a three to four-year recession/depression which is not treatable by policy makers and could ultimately cause a total collapse of our financial system. — Assets Purchased: U.S. Treasury Bills, Notes and Bonds; Gold and “virtuous non-U.S. currencies”. — Assets Sold: Common Stocks including the finest companies in America. – Experts: Nouriel Roubini, Jimmy Rogers, Marc Faber, etc., etc. etc.

The T-bills and gold are easy for us to see through. There is a bubble of fear and uncertainty. Therefore, any asset which seems to give protection against fear should get way over-priced at the height of the fear. We wonder how people are going to feel about earning little or no interest for years. I drove by a guy on Pima Road in North Scottsdale today selling Safes on the side of the road. Gun sales are through the roof. These actually make more sense to me than the money-market funds, savings accounts, CD’s and T-bills. If the premier U.S. companies don’t survive and prosper, there will be no tax revenue to insure deposits, back money-market funds and redeem government debt. If our Disney, Abbott Labs and WalMart don’t make it, you need a one-acre garden, a nearby water supply and a set of big guns and lots of ammo.

As bad as this decline has beaten our stocks in the short-run, you’d think that we wouldn’t love it just as much as the other “well-known facts”. You’d be wrong. This one is possibly setting up faithful and persevering blue-chip stock investors for the positive ride of their lifetime. First, today’s Wall Street Journal is talking about an additional decline of more than 20% off a stock market which has been pummeled more than any market other than the 1929-32 “Great Depression” decline. Second, sentiment polls from the American Association of Individual Investors and Bespoke Research show that a MAJORITY of market participants believe that the stock market will fall more than 20% from here. Third, our wonderful and well-trained clients have called me more times in the last two weeks to tell me that the market is going down more and is going down for another one to two years. All these prognostications coming from folks we’ve worked for for years and have n ever had an personal opinion about the short-term stock market direction prior to this year.Fourth, there is more cash on the sidelines in money-market funds relative to total U.S. stock market capitalization than any time in the last 60 years.

We could go on all day with additional evidence, but we think you get the picture. We believe there has probably never been a better day to buy quality U.S. stocks (for a two to three-year holding period) in our lifetime than today. The reason is that everyone knows that the opposite is so and, therefore, “nobody knows nothin’.”

BUY-BUY-BUY

Warm Regards,

William Smead

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

Dear Clients and Prospective Clients:

In the midst of this historically poor start to the year 2009 in the stock market (S&P 500 year-to-date return), we thought it would be helpful to give you some reading in between the lines of the Berkshire Hathaway Annual Letter.

1) “Book Value fell 9.6% and the stock price fell 32%”

Translation: This was the worst year out of 44 on an absolute basis for Berkshire Hathaway. Book value has grown at 20.3% on average over 44 years!

2) “By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.”

Translation: What we at SCM describe as an “economic coma” has been as swift and violent as any Warren Buffett has seen in his adult business life.

3) “Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 21.5% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges. Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.”

Translation: It has been a long time since we had a major and painful economic contraction. We have grown soft because of it and the steep decline in stocks has every intention of robbing all of us of our optimism. It won’t rob Warren’s and it won’t rob ours at SCM.

4) “Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded again. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’ t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.”

Translation: Don’t extrapolate forward the recent down trend. Picture where you are as an owner of common stocks and where you want to be in five years and stick with your discipline.

5) “I told you in an earlier part of this report that last year I made a major mistake of commission (and maybe more; this one sticks out). Without urging from Charlie or anyone else, I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.”

Translation: Warren got caught in the “Peak Oil” Bubble last year and believes that oil will rise in price in the future. Too many investment people agree with Warren and we believe that he will need a great deal of time to get even on Conoco.

6) “I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 m illion for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”

Translation: Warren’s existing holdings in Wells Fargo, American Express axp and US Bank usb punished him in the last year and he got burned badly by dabbling in a few new financial institutions. There is grace for us at SCM in his difficulties!

7) “The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today’s could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms. When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.

Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”

Translation: Good quality stocks and bonds are underpriced and U.S. Treasuries, money market funds, CD’s and savings accounts are overpriced! However, to gain the benefit from this investment discrepancy you must deal with the possibility that the markets continue to deepen the underpricing and raise the overpricing!

We know we have given you a great deal to consider, but in these trying times in investing we hope we are serving you well by modeling the behavior of the greatest investor of all time.

Warm Regards,

William Smead

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

Dear Clients and Prospective Clients:

I’m fond of saying that the Math you need to succeed in business is learned by the end of 7th grade. If you can do percentages and simple algebraic equations, you can be a huge success! There are two very important areas of investing and our economy which simple math could tell you are going to change.

The first is in housing. The loans attached to housing are the “Achilles Heel” of this economy. All the securities and balance sheets which are poisoned by mortgages have at their core an unknown. When and at what price will housing bottom in the markets that dominated mortgage origination (California, Florida, Arizona and Nevada)? Those states have also dominated foreclosure statistics and provided the most toxic paper in the most egregious mortgage-backed securities market. If the demand for homes remains relatively constant, then it is the supply of homes on the market which tell you if some kind of equilibrium is being reached.

Here is the simple math. Housing starts were the lowest in 50 years in January at an annualized pace of 466,000 new homes. Don’t just pass that statistic by. MORE HOUSES WERE STARTED IN THE U.S. IN 1960 WHEN WE HAD A TOTAL POPULATION OF 180 MILLION THAN ARE BEING STARTED TODAY WITH A P0PULATION OF 300 MILLION! Home sales are up sharply in the worst performing states. There are about 1.3 million homes absorbed each year in the U.S. The inventory of unsold homes dropped recently to 9-months supply from a high of 11-months last year. The media and internet outlets want you to believe that additional layoffs and foreclosures are the key to housing finding a bottom. However, we believe those negatives are only slowing the positives in rebalancing supply and demand. With more babies being born in the U.S. in 2007 and likely in 2008 than any year since 1957, it is likely that demand is not constant, but rather is growing underneath the surface. The new stimulus bill gives an outright $8000 tax credit to first-time home buyers (anyone who hasn’t owned a home for three years) which does not have to be paid back if you keep the home for three years.

Conclusion: More demand and less supply will lead to equilibrium. Equilibrium in housing prices would clarify the underlying value of mortgages and mortgage-backed securities. Clarification of mortgage and mortgage-backed security values could define financial institution book values. Definition of “real” book values would refocus investors on earnings power. Refocusing on earnings power would restore confidence in the surviving financial institutions and the stock market in general!

The second area for discussion is gold. I read recently that approximately 75% of the demand for gold comes in the form of jewelry. If you read the reports of any jewelry company, you’ll find that the demand for jewelry is down significantly (Tiffany Christmas sales down 21%). The price of gold is up to $970 per ounce this morning and has risen over the last three months. If 75% of your demand drops by 20%, you have a loss in demand of 15% (assuming supply is constant). For prices to rise while that was going on, you needed speculators, who make up something less than 25% of demand, to have demanded everything that jewelry buyers normally demand and buy a great deal more! It is too bad for them that supply is not constant. Thanks to M.C. Hammer and Ed McMahon, people are turning in their gold for cash in record numbers; enough to justify expensive adds at the Super Bowl and all day on television.

Conclusion: Less demand and more supply of gold will lead to much lower prices at the point that speculators run out of bullets in their gun (remember what happened last summer when Oil speculators ran out of “Peak Oil Theory” bullets in the face of falling oil consumption). Those bullets are all “fear’ trade bullets. The “fear” trade goes away when equilibrium is reached in housing, the financial institutions are stabilized and some confidence comes back into our economy. We at Smead Capital Management recommend that long-term investors sell their gold before the “fear” trade disappears and before two plus two goes back to equaling four.

Best Wishes,

William Smead

William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

Sometimes you can’t hear because of all the noise and we at Smead Capital Management believe that this is one of those times. Let me share some interesting facts getting lost in all the noise this morning.

The inventory of homes for sale has dropped to a nine-month supply from as high as 11-months last year.

It is more economic in Seattle to buy a home with a $300,000 mortgage than it is to rent an appealing apartment.

Oil prices are holding below $40 per barrel, even though OPEC and an Army of investors are doing everything in their power to reverse the price.

More Babies were born in the U.S. in 2007 than in any year since 1957. We think that 2008 exceeded 2007 and as much as everyone has stayed home the last three months, 2009 could be a baby barn-burner.

We could probably be at the peak of distressed sales as a percentage of overall home sales.

The Federal Reserve reported that the savings rate has already risen to 3.8% in the U.S. from negative levels.

Many Americans thought that our country was going to be “ruined” by the “Socialist Policies” of the Roosevelt Administration in late 1932.

Stocks rose 370% from July 8th of 1932 to March of 1937.

Many Americans think that our country is going to be “ruined” by the “Socialist Policies” of the Obama Administration in early 2009.

The stock market has been miserable today, but most stocks are a long way from their November lows.

The U.S. Government seeks to stabilize the financial system and slow the economic contraction.

Unemployment is at 7.6% and could be headed as high as 9 or 10%.

Unemployment bottomed at 14.3% in 1937!

“History never repeats itself but it often rhymes.” (Mark Twain)

Best Wishes,

William Smead

William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

Andy Grove was the CEO of Intel for many years and was asked what the best advice was that he’d ever been given in business. His answer was that a professor at the City College of New York taught him that “When everyone knows that something is so, nobody knows nothing”. It means that when the crowd of market participants reach more than 80% agreement on matters of business or investng, you have to disagree with them and do the opposite of what the crowd is doing.

A few examples for newer readers. When everyone thought in 1998-1999 that the profit to be made from tech investments was unlimited, you had to flee the area. A year ago when investors were rabid for international stocks (especially emerging markets), you had to assume the bubble would burst. Last summer when Oil hit $145 per barrel and commodities were flying high, we warned everyone who would listen to get clear and forget you’d ever heard of BHP Billiton, Transocean, Mosaic and Freeport McMoran.

At Smead Capital Management we crave the opportunities created by this phenomena we call a ”Well-Known Fact”, which is a body of economic information which is known by all participants and has been acted on by the 80% majority. Unfortunately, for the last 10 years, most of the “Well-Known Facts” were things to avoid as opposed to sectors made attractive for new investments. Avoiding overvalued areas saves you money while pursuing undevalued sectors could make us wealthy.

I’m pleased to report the latest “Well-Known Fact”. The “new” fact is that the recession which started a year ago is going to be the longest and deepest since the 1930′s. Therefore, the crowd of investors assume that the most violent decline since the 1930′s in the U.S. stock market (from October of 2007 to November 20th of 2008) is not good enough to discount all the bad news which will come for however many months that the recession lasts. Individual investors are approaching having 2.5 times as much of their aggregate household assets in treasury bills, checking, savings and certificates of deposit as they own directly in common stock. It is almost the exact opposite of the top of the market at the end of 1999 when they owned $10 trillion of common stock directly and had $4 trillion in the safest and historically lowest paying instruments. Warren Buffett says, “Uncertainty is the friend of the buyer of long-term values” and “So if you wait for the robins, spring will be over”.

Here is our opinion based on the current “Well-Known Fact”:

Buy quality U.S. stocks with balance sheet strength and powerful brands.

Assume that Treasury interest rates will rise dramatically in the next two years.

Assume that recently hot sectors like commodities, oil, international/emerging market and gold will be dead money in the “Next Great U.S. Stock Market.”

Assume the largest self-help and psychological counseling group in the U.S. in 2010 will be made up of the folks who sat on low interest rate money market and “cash is king” investments at the end of 2008 and watched a once in a lifetime fire sale in America’s finest companies pass them by.

Lastly, if we don’t currently manage money for you and your portfolio doesn’t line up well with this advice, don’t waste time getting the dust off your feet before you call us.

Best Wishes,

William Smead