William Smead
Chief Executive Officer
Chief Investment Officer

Dear Clients and Prospective Clients:

In the movie, “Sixth Sense”, the little boy could see dead people. Unbeknownst to the movie viewers, the dead people included the character played by Bruce Willis who was counseling him. On one hand, Willis’s Character helped calm this child’s fears surrounding the haunting episodes he had with dead people. At the moment we see dead investors/consumers and the U.S. Government is playing the role Bruce Willis played. Much like receiving counseling from a dead person, the U.S. Government’s Rescue and Stimulus plans can serve to make the patient (investors and consumers) more nervous.

SCM Portfolio Manager Tony Scherrer has come up with a great analogy to explain the current circumstances which we have described as an “Economic or Business Coma”. He reminded us that some people who have come out of comas tell loved ones that visited them that they heard them speaking while they were comatose! At Smead Capital Management we are speaking and writing to many folks out there who are in an investment coma. They are listening and hearing us, but they are immobilized by what they see around them. We know the news has been horrible on the job front and in the stock market (worst January in history) and here in Seattle we are just now getting hit by the layoffs and business closures that most of the country has been going through for over a year.

Many of those who are listening to us will call us when they and everyone else come out of this business coma. Unfortunately, they are likely to pay dramatically more to buy shares of the best U.S. companies at that time. The primary reason for not buying into our portfolios now is the worry that the coma will last longer than expected and we will look foolish in six to twelve months. There is $8 Trillion dollars sitting in T-bills, money-market funds, short-term CD’s, checking and savings accounts and those amounts represent incredibly high levels versus Total U.S. Stock Market Capitalization. The offset to the fear of looking foolish is the fear of avoiding a possible rampage of buyers. Imagine what it will look like if most of these people come out of the business coma at the same time and all try to reestablish their investments simultaneously.

On top of individual investors being in a coma, institutional investors like pension plans and endowment funds have spent the last three years chasing performance under the guise of wide asset-class diversification. Their emerging market, hedge fund, private equity, energy and commodity investments not only didn’t protect them, but also turned out to be illiquid in many cases. We see massive capital employed in dead investment strategies which will haunt them for years in the “Next Great U.S. Stock Market.” To get back on track for retirees and organizations, these institutional investors could ultimately come back to U.S. Large Cap Stocks and take advantage of their long-term historical success and constant liquidity. These institutional investors could be part of the rampage as well as they give up on the popular strategies of the last three years.

We have no idea when this business/economic coma ends, but we unequivocally believe it will end as all the previous ones did! We believe that those of us who act while we are surrounded by dead investors and consumers could be proven to have a “Sixth Sense”.

Best Wishes,

William Smead

If you can’t see the video above, click here to watch the segment

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