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Dear Clients and Prospective Clients:

In prior missives, we at Smead Capital Management have shared with you that there is a large group of money managers and investors who are counted as bullish, but are actually bearish. These investors own the reflation trade or what we like to refer to as “Peak Oil Mini-Me”. Their thesis says that the Federal Reserve and U.S. Treasury are flooding the world with dollars and “printing” money and the only way to take advantage of those facts is to be long oil, gold and other commodities. The current market correction is all about them and the truth behind their thesis.

We believe the truth is that if all that the government is doing causes a rapid improvement in the economy and quickly leads to very high levels of inflation, we’ve got even bigger problems later on to deal with. We sincerely believe these “Long Bears” are wrong. Their frustration is causing a significant and temporary pullback in the S&P 500 Index. We believe that the U.S. Economy will begin a long slow growth phase beginning in the fourth quarter of this year (Oct. 1-Dec. 31). A year ago the economy went into a coma in September. We have since reset our spending 10% lower than the prior year. This spending cut is much deeper than 10% appears because it is about half of the discretionary spending we do each month. The recovery doesn’t occur because of what the government does. Growth occurs because the economic benchmark has been lowered and economic activity is compared to how you were doing in the same quarter of the prior year.

The Federal Reserve’s actions and the government stimulus doesn’t scare us because of the banks need to replenish their capital. They will return to a good business of lending money to credit worthy people with sizeable down payments. A recent study by Stan Liebowitz in the Wall Street Journal has shown that the number one correlation to foreclosure was the lack of any down payment.

The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home. The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008). A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.

This return to normal banking will take three to five years. At the same time, individual households and businesses are going to be very hesitant for years and maybe decades to borrow money. Add it all up and you quickly decide that we will not recover by returning to the foolish lending and borrowing of the last ten years. In our minds this means that we won’t reflate the economy. If you don’t reflate the economy, the case for oil, gold and commodities go right out the window and will look foolish; especially after last year’s oil and commodity bubble burst. History shows that bubble markets are dead money for a long time after breaking, just look at the Nasdaq today compared to the peak of the tech bubble in early 2000.

So who wins in this scenario? The winners will be the “Long Bulls”. The “Long Bulls” believe that all the fear of the last 18 months has left the prices of many of the world’s best companies far below their intrinsic value. A long and slow economic recovery with an accommodative Federal Reserve could lay the groundwork for businesses with strong balance sheets and wide moats to gain market share. This would allow them to grow nicely from the “reset” of consumer spending levels. It could be a long period without excesses, which are usually created by too much leverage. As the debts of individuals and the government are paid back, an automatic restraint is put on the economy keeping it from overheating. Single-digit earnings growth in a slow economic era could produce price-to-earnings expansion. We believe large quality company shares will be the place to be for the next five to seven years.

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.

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Dear Clients and Prospective Clients:

One of the most famous parables in the Bible can be found in the book of Luke, the Seventh Chapter. Jesus compares the Kingdom of God to farming. The farmer spreads seed around the land. Some falls on the path, gets trampled and eaten by birds. Some lands on the rocks and does not grow due to a lack of moisture. Some grows up among the thorns and gets choked in the process. Some falls on good soil and yields 100 times itself.

In the long run, the stock market is the same as farming. Most investors use an approach designed to produce short-run success. Some use momentum models designed to get on the hot path, only to get eaten up by paying too much for future success. Some invest in concept stocks and buck such low probabilities that their losers rob all the moisture from their winners. Some seek to predict the economy or use wide asset allocation and choke on errant macro-economic predictions or faith in obscure or illiquid asset classes. Some rely on wide moats and the generation of ample and long lasting free cash flow that can make many times their original investment over many decades.

At Smead Capital Management, we’d like to focus on the successful part of the farming analogy. It refers to “good soil”. What is good soil for an investor? We believe it is buying shares of an outstanding business for less than its intrinsic value and holding it for years as the company continues to succeed. We believe we are more likely to do that in companies which will survive and prosper much longer than other companies. The most important factors in longevity for a public company are balance sheet, product necessity and strength of moat.

To understand why we think this way we would like to refer you to the writing of Brett Arends of the “Wall Street Journal” in a May 11th article called, “How to Value Stocks? Ignore Economic News”. In it he chronicles the work of Ben Inker, Director of Asset Allocation at contrarian fund company Grantham Mayo Van Otterloo & Company (GMO). Inker points out that the present value or intrinsic value of a company is the discounted value of all future cash flows and dividends. And Inker can’t understand why people put so much emphasis on what is going on in the stock market right now or in the economy next year when they seek to analyze common stocks. He thinks they are mistaken for two reasons.

First, because most of the value of shares really depends on the cash they will generate many years, even decades, ahead. The next few years are only a minuscule part of the equation. “Since stocks do not have an expiration date and dividends grow over time,” Mr. Inker argues, “the duration of stocks is extremely long. If we assume that half of the return from stocks in a given year comes from the dividends and half from the growth in dividends, most of the value of stocks comes from cash flows in the distant future.”

How distant? Using Mr. Inker’s hypothesis, it turns out that about 75% of the value of shares is actually based on dividends that will be paid more than eleven years from now. Half the value is based on dividends to be paid after 25 years, and a quarter on those to be paid after about 50 years.

In other words, when you look at the market today, three quarters of its true value is based on what companies will earn and pay out after 2020 and half is based on what they will do after 2034. So really, how much attention should you pay to next quarter’s earnings?

We at SCM love his logical and mathematical conclusion. Since most of the current value of a company comes from discounting cash flows and dividends coming years and decades from now, our analysis should be spent trying to ferret out the companies which can survive at high levels of profitability the longest. It reminds us of why Warren Buffett paid an astounding 18 times trailing earnings to buy a large stake in Coca Cola back in 1988. When asked why Buffett answered, “‘Let’s say you were going away for ten years,’ he explained. and you wanted to make one investment and you know everything that you know now, and you couldn’t change it while you’re gone. What would you think about?’” He knew that he could discount cash flows and dividends thirty, forty and even fifty years out and Inker proves that those future flows make up most of the current or intrinsic value of a stock.

His second reason is that economic performance follows a fairly consistent long-term path and gravitates towards the mean. If the economy has been terrible, it is likely to revert back to acting better. If it has been terrific for quite awhile, it is headed for difficulty. At SCM we are asking whether the current economic trouble is making our companies more or less likely to survive and prosper for many decades? We think the overwhelming answer is that the current circumstances are making the kinds of companies we like to own more likely to survive! Six Flags declares bankruptcy and Disney gets stronger. Washington Mutual disappears and Wells Fargo gets stronger. Nobody wants to finance young biotechs, so Merck and Pfizer will buy most of the great future science. The list goes on and on. The economic cleansing of the last two years has done more to strengthen and widen the moats of strong balance sheet companies with powerful brands and distribution chains than any phase in history in our opinion. However, since these facts are long term in nature, the marketplace actually discounts these virtues rather than giving them their usual premium. We believe that the next few years could very well rectify the under valuation of the most valuable franchises in business and our companies could turn out to be “good soil”. We will leave investments on the path, on a rock or in the thorns to someone else.

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.

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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.

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Dear Clients and Prospective Clients:

If there is any agreement out there among investors, it surrounds the measures being taken by the Federal Reserve to stabilize the financial system and prevent a 1930’s style contraction. These same investors agree that these actions to revive our economy will lead to high levels of inflation. We’ve rarely seen a future expectation get baked into the stock market as quickly as this topic. People from the political right (who bash Obama) and those from the left (who like Warren Buffett love him) are in agreement. Money could be made by playing the devil’s advocate. At Smead Capital Management, we’d like to make the case that this crowd could be wrong. To understand why, we have to take you back to childhood games of Monopoly.

In the winter when we were trapped inside or in the summer when baseball was over, my friends and I played hours of Monopoly. The game is played on a board representing four streets or neighborhoods. Each player starts with $2000 in cash and collects $200 for every time they pass Go. The bank exists for collecting payments for the purchase of properties and buildings. Its second function is paying rewards that can be reaped by landing on certain favorable squares. While one travels around the board, they can use their money to buy properties. If you accumulate two to three properties in the same neighborhood, you can buy houses and ultimately hotels to place on your properties. When an opposing player lands on your property, they pay you rent. The more real estate you own as well as the amount of additions (houses and hotels) to the property, the greater the rent that is paid. The object of the game is to create monopolies and eventually bankrupt your opponents.

To this point the actions of Fed Chairman Ben Bernanke and the Federal Reserve Board have been both systematic (backing money-market funds) and stimulative (dramatically growing the money supply). They sought to and succeeded in driving down interest rates and reestablished normal inter-bank borrowing in the process. Both conservatives and liberals are convinced that the huge increase in the money supply (printing of money) will result in an economic recovery which is followed soon after by very high levels of inflation.

Bernanke’s actions are the equivalent of doubling the amount of money held by the bank in the game of Monopoly. If the bank has twice as much money and you pass Go, they give you $200 just like when the bank had less. None of the bank paid rewards change because of the bank having more money. The only way to inflate the game or inflate the economy is to directly put money into the hands of the players. Ironically, to speed up the game as kids, we did just that and gave each player an extra $2,000 or stuffed the center area with thousands of dollars. The more money players had, the faster they bought property and buildings. The faster the Monopolies developed, the faster that everyone but the winner went bankrupt.

The Federal Reserve has increased the money supply immensely, but the institutions and systems for putting the money into the hands of the players are not functioning. Banks are building capital to meet stress tests and working hard to work through existing loans on the books. Non-bank lenders have practically disappeared from lending and securitization is nearly non-existent. Savers sit in CD’s and money-market funds at dismally low interest rates and borrowers cut spending to pay off prior debts and build meaningful savings. They are passing Go and getting the same $200 even though the bank has twice as much money as they did before. Investors have twice as much cash in money market funds as any historical low point in the stock market for forty years. The lower rates are great for getting through the existing debts, but are a big drag on the incomes of conservative fixed-income investors.

Unless the Federal Reserve starts paying $400 for passing Go or people who have learned all the negatives about borrowed money suddenly start borrowing again, the inflation fears are over-blown at best and possibly dead wrong at worst. We will see you at Boardwalk or Park Place if these fears prove incorrect.

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.

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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.

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Dear Clients and Prospective Clients:

There are two opinions we hold at Smead Capital Management which are very contrary to the conventional wisdom in the marketplace. First, we feel that we are much closer to behavioral changes in the automobile and environmental world than most people think. Second, we believe we are about to enter a long stretch of outperformance among U.S. stocks by large capitalization companies which fit our eight criteria. We think our “gut feelings” on these subjects are correct, but once in a while you need a little encouragement when your opinion is especially contrary. Jeremy Grantham, of Grantham, Mayo, Van Otterloo & Co. (GMO) fame, is probably the most respected institutional asset allocator in the world today. He chose in the last few weeks to forcefully back us on our arguments and reasoning.

For our thoughts on Oil and Oil-oriented investments, see our recent Missive titled “Bull Markets in Oats and Hay”. Our thesis assumes that the change to electric and hybrid cars will be much swifter than most investors think (5 to 10 years). This swift transition could destroy the “Peak Oil” mentality which had developed last year as oil reached $147 per barrel. It took 25 years for the U.S. to move from horses to cars (1900 to 1925) and we believe everything changes much faster now than in the past. We are under-weighting Oil and Oil service stocks despite their recent popularity.

Grantham seems to be in agreement on the changes in autos, but his opinion is driven by climate change. In a recent interview with Smart Money he said this: “The people who move quickly in this market can make money. The people who invest in energy alternatives will make more. Alternative energies and combating climate change are the single most important economic initiatives over the next 10 years-really over the next 50 years. It will be a very exciting next 50 years.” A victory for energy alternatives is a loss for Oil and Oil Service companies in our opinion.

We always like our investment style of seeking out high quality “blue chips” companies which are out of favor, but once every 10 to 15 years they get especially attractive relative to all the other places people can put their money in the U.S. Grantham and his firm run intense mathematical models to try and determine which asset classes should perform the best over the next seven years. They now manage directly over $80 billion in assets. Here is what Grantham said in a series of interviews at Morningstar’s recent investor conference and Forbes magazine:

Grantham expects a subset of U.S. stocks — those he labels “high quality” — to produce after-inflation annualized returns of 11.5% over the next seven years. Five-and-a-half percentage points on an annualized basis is an enormous difference — and gives investors plenty of incentive to identify those “high quality” stocks.

Although Grantham doesn’t directly define “high quality,” he provides some clues in an interview with Forbes in which he said, “And the best bet, for my money, then and now, a year later, was to buy the great franchise companies, the great quality companies.” This suggests that he favors companies that possess a moat — a sustainable competitive advantage — and that earn excess returns over their cost of capital.

At Smead Capital Management we have solved Jeremy Grantham’s dilemma and have come up with the eight criteria below to define high quality and use it to create our common stock portfolios.

1) Strong Balance Sheet – Preferably more cash than debt, the ability to pay off debt in the next couple years out of free cash flow or companies with debt that have very consistent customer bases

2) Long History of Profits and Dividends (or stock buybacks)

3) History of Shareholder Friendliness - Making shareholder friendly choices with available capital

4) Strong Insider Ownership – Preferably with recent purchases

5) Easy to Understand – Business meets a sustainable economic need

6) High levels of free cash flow

7) Wide Moat – High levels of profitability maintained by barriers to entry

8 ) Low Price in relation to the fundamentals of the business (price-to-earnings/sales/cash flow/book value) in comparison to the last five years

Grantham believes as we do that economic growth could be muted by the debts over-hanging the economy from the last ten years. He thinks that China and India can’t grow as fast without the U.S. returning to our prior spending levels and he doesn’t foresee that in the next seven years. We believe a huge number of retirement age baby boomers could result in sustained high unemployment figures. This “New Boomer Austerity” or attitude could cause the existing spending “reset” (like what we’ve seen since September of 2008) to last for as long as a decade. In that environment, competing with financially strong and well entrenched companies like WalMart, Microsoft, Merck and Disney could be difficult at best and impossible in many cases. The ultimate irony of all this is these “quality” companies trade at or below market P/E ratios and pay above average dividends for the most part. Numerous years of under-performance and reversion to the mean is driving GMO’s computer models and Jeremy’s opinion. Our stomachs are strengthened!

Stay thirsty for investment success my Friends,

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.

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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.

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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.

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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.

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Dear Clients and Prospective Clients:

Economists, policy makers, regulators and investors spend most of their adult life worrying about the worst Economic calamity of their early adulthood. From 1946 to 1973, every time we had a recession it brought intense fear of the next “Great Depression” happening. Despite hyper-vigilance on the part of economists and policy makers, it took 30 years for investor’s to trust stocks thereafter. They should have been more confident as the Dow Jones Industrial Average rose from 92.92 on April 28th, 1942 to 995.15 by February 9th, 1966. This appreciation does not take into account dividends. The great run in the stock market in the 1950’s happened while we worked off the debts incurred fighting the Depression and World War II.

Inflation reared its ugly head in the 1960’s and 1970’s. Economists like Alan Greenspan and Paul Volcker have caused us to be hyper-vigilant since then to not allow inflation to find its footing. Despite the fact that inflation fell all through the 1980’s and 1990’s, investor’s did not trust stocks until the late 1990’s and by then most of the good money had been made.

Today the biggest economic calamity in the minds of economists, policy makers, regulators and investors has been the over-capitalization of real estate and high levels of debt attached to our economy. Economists like Nouriel Roubini and policy makers like Barnie Frank are leading the charge to remind us to not let the animals out of the barn, now that they are already out.

We at Smead Capital Management believe that the real estate markets will be tame for years. Working down our current debt levels the next ten years will indelibly etch better and healthier attitudes into borrowers of all kinds. We believe that rather than waiting 20 years to trust good quality stocks, we should trust them right now.

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.

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Dear Clients and Prospective Clients:

Peter Lynch, the great investor, ran the Fidelity Magellan Fund from 1979 to 1992 and had a spectacular track record of success. One of his favorite concepts was investing in what you see going on around you. By doing follow up research, you would then invest in companies to take advantage of what you are observing. I went to New York on business last week and entered into the laboratory of America.

Upon entering the plane for my flight, I got to watch the stewardesses and steward demand that people shut off their cellular phones. For some of these people I thought it was going to take physical force. Seeing the pain of shutting them down wasn’t enough. When the plane landed in New York, you would have thought that these were children waiting to open gifts on Christmas morning. The moment that the Captain gave the go ahead there was a mad rush to turn on the phones and make up for the time spent incommunicado. You might wonder why this is so important from an investment standpoint!

Last week a major research firm on Wall Street downgraded Verizon and AT&T from buy to neutral. Their reasoning went like this. As of last quarter there are more cell phone-only households in the U.S. than landline-only homes. In their mind this represented the decline in the very profitable landline business. However, my observation of these cellular addicted flyers tells us that as landlines disappear and everyone ultimately goes cellular that the two dominate companies will have amazing price raising flexibility. While you have a landline you have a choice, but when you only have a cell phone you won’t cancel your service no matter what the price goes up to. Price flexibility is a major profit opportunity as are all the new services that we will pay for as our phones get more functional and sophisticated.

A second laboratory is the two homes we own. One is in North Scottsdale, AZ and the other is in Shoreline, WA. Both are soon to be a bonanza for Home Depot and other companies which are involved in the home improvement and home remodel worlds. In Scottsdale, we need to paint the inside of the house and hang paintings. Our pool has a crack on the outside that needs fixed. In Shoreline, we need new windows and carpet upstairs. We need to stain the deck and landscape and bark the yard. Our kitchen could use a remodel. We have been postponing this work as much as possible. We at Smead Capital Management think that most Americans have been postponing the work that needs done at their homes also. When the pent up demand cuts loose, business could be quite strong!

We are very confident investors in the cellular phone industry and the home improvement market.

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.

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Dear Clients and Prospective Clients:

I believe that an individual’s income is close to the average of their ten best friends. This could be why an estimated 35,000 people sought to make friends with Warren Buffett and Charlie Munger in Omaha on Saturday at the Berkshire Hathaway Annual Meeting. Buffett is the Chairman and Chief Investment Officer of Berkshire and is the world’s third wealthiest man, while Charlie is Vice-Chairman and has a $1.5 Billion net worth (which is not chump change). Even at the ages of 78 and 85, respectively, these two billionaire investors can hand out the wisdom.

What I find the most interesting about what these men say about investing is the clarity and simplicity of their investment decisions. Unfortunately for most investors, the part that holds most people back from imitating these great investors is the patience, contrarianism and humility associated with executing a non-widely diversified buy and hold common stock investing style. At Smead Capital Management we seek to practice these virtues.

Here are examples from last weekend of these separating virtues:

On the subject of patience, Charlie Munger said Friday, “I think the reality is that if you hold a stock for a long long term even though it’s screamingly successful as an investment, you will have huge declines in the value of that stock two or three times in half a century. And I don’t think that should bother long term holders all that much.”

While everyone is scared to death of banks, the ultra contrary Buffett said, “I would love to buy all of US Bancorp or I would love to buy all of Wells Fargo, if we were allowed to do it.” Buffett spoke again about Wells Fargo and the $9 price it had earlier this year. “If I had put all my net worth in one stock, that would be the stock.” This is a stock he started buying in the last major financial crisis in 1991.

On the search for a Chief Investment Officer to replace him in the future, Buffett shared that he has found four good potential replacements. Instead of chasing recent out-performance (like most investors do), he shared that none of them had beaten the S&P 500 Index last year (which means they lost more than 37% of their beginning year value). He and Munger also added that sitting on large amounts of cash to avoid last year’s decline did not impress them or influence their decision.

On another note of humility, Warren had to eat some humble pie. “Buffett said Saturday that he was ‘disappointed’ when Moody’s cut its Berkshire ratings, though he said the decision was lamentable mostly because it led to a 1oss of ‘bragging rights’ - not because it will materially raise Berkshire’s borrowing costs.” Maybe it is God’s way of getting him back for undercutting the municipal bond insurance companies and then using information they had shared with him to compete in the bond insurance business in the middle of the panic and the credit crisis last year. Warren needs to relearn the Mike Milken lesson of the junk bond era of the 1980’s. Leave some business for everyone else and not just crumbs.

On simplicity, both men reiterated that if you need a calculator for making an investment decision or if your investment relies on computing some sophisticated mathematical formula, in their minds it is a bad idea. I always told my kids that all the math you need to learn to make a great deal of money in investing or in business is learned by the end of 7th grade.

Reading and listening to these two great investors over the weekend makes those of us at SCM that much more excited about the great companies we own, the investors who are along with us for the ride and how much money we could make in the aftermath of the recent fire sale in the stock market. You supply the patience and we’ll supply what we think are the great companies because the stock market has already handed out the humility!

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.

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Dear Clients and Prospective Clients:

We are all being drowned in information each day. Most of this information has to do with the effect of the current economic contraction and the policies being used to turn things around. Since it seems that nobody wants to talk about wonderful companies, I’d thought we’d share some of Smead Capital Management’s opinions on the subject.

Here’s a list of some of the attributes of a wonderful company in our eyes:
1) High levels of profitability on invested capital with little or no leverage
2) Number one or two in the industry
3) Brand synonymous with product or industry
4) Transparency of management
5) Non-cyclical core business
6) High Barriers to entry (Strong Moat)

We could go on, but let me get to the point. In 29 years in the investment business we’ve learned that wealth is created by owning wonderful businesses for a long time and that your returns are enhanced if you get to buy them when their price is depressed. Usually the only time wonderful businesses get depressed in price is when the whole stock market goes way down and/or the economy contracts and provides short-term difficulty to even the strongest businesses.

We believe that three to five years from now people will look back and say, “What was I thinking about in late 2008 and early 2009 as I sat on low interest paying vehicles and didn’t add to existing holdings or use these bargains to get in somewhere around the ground floor?” Help us to help you!

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.

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Dear Clients and Prospective Clients:

We at Smead Capital Management love how gullible and short-term oriented most investors are. One of our favorite ways to understand this is when a company is the subject of a major public relations (PR) campaign. The PR campaign is almost always the product of someone that wants to gain some kind of financial advantage by smearing the company involved. A few examples would probably be helpful.

Did any of you see the documentary six years ago called, “Super Size Me”? A young man ate three meals a day at McDonald’s for six weeks and had to super-size his order if the employee asked him “Would you like to Super Size this?”. He gained 23 pounds and saw his cholesterol shoot through the roof. McDonald’s was viewed as evil at that time and their stock bottomed out around $15 per share. Today it is closer to $55/share.

WalMart has been the recipient of a major, multi-year PR campaign to present them as evil to support a nationwide attempt at unionization. First, the campaign convinced everyone that small business owners in the areas where WalMart put their stores were being knocked out of business. Second, WalMart was vilified for doing what thousands of companies across America do by employing some of their workers for less than 30 hours per week to avoid paying benefits to them. Everyone learned to hate both McDonald’s and WalMart, but a funny thing happened on the way to the public opinion forum. We’ve had an ugly recession and economic contraction and it just so happens that when people tighten their belt and look to save money on fast food and just about everything else, they come running to these two great companies. Notice how the PR campaigns have disappeared from the news. Notice how well the stocks have done in a quantumly difficult environment.

This brings us to today’s great PR campaign to smear the makers of Pharmaceutical products. President Obama seeks to cut the annual cost of healthcare in the U.S. significantly during his time in office. Most gullible Americans and short-term oriented investors believe that the high cost of drugs is the reason that healthcare is so expensive in the U.S. They think that the employees of drug companies care about nothing besides profits and know that if the prices of drugs were fixed by the government and all our healthcare was rationed, then everything would be alright.

The truth is that healthcare is getting more and more expensive because more and more people are demanding it, expensive technology keeps improving it and massive numbers of people over the age of 60 are living way longer than any prior generation. These older folks want quality of life and long life as well. This means they will have to put up with chronic illnesses that are most cost effectively treated with pharmaceutical products. The PR campaign is lead by trial lawyers, who have this wonderful love/hate relationship with the drug companies. They smear the drug companies to win verdicts in jury trials for the damaging side affects of any number of drugs. They then quietly root for the success of the pharmaceutical companies so that the drug companies can afford to pay the judgements that come from the future less than perfect, but effective medicines.

Just like McDonald’s and WalMart used to have depressed price to earnings multiples because of successful negative PR campaigns, the finest big pharma and biotechnology companies have them today. Will the story play out any different over the next few years?

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.

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Dear Clients and Prospective Clients:

Found in the old testament book of Genesis in chapter 6 is the story of Noah and the flood. God is described as “very angry” with the behavior of the people he created and instead of eliminating everyone and everything he chose to extend grace to a man named Noah, his wife, sons and their spouses. Once God chose Noah he gave him marching orders to build an Ark. This huge boat was to be 450 feet long, 75 feet high and 45 feet tall. Noah and his three sons obediently spent over 100 years building the Ark and explained to people that they needed to turn from their wicked ways and join his family in the boat.

This might have been the most difficult task ever set in front of a mortal man in history. There is no evidence in the first five chapters of the bible that it had ever rained before. Life spans were very long in Noah’s time (600-770 years), but it took about 20% of his life to build the Ark. Noah had no formal religion or community support mechanism surrounding him and his family. He had to be the ultimate contrarian and perform the whole time as if he were going to be right all along. When the flood finally receded and Noah was vindicated, God provided a rainbow as a sign that he would never drown everyone again and as a reminder to his people.

At Smead Capital Management we formed a company two years ago based on a series of things we believe about investing. We are building a mutual fund and separate account management business at SCM which is our Ark. Here are ways that we believe our work is similar to Noah’s task:

1) It hasn’t been easy to make money in stocks since early 1998 and that is equivalent to not raining for a long time.

2) Many retired investors wonder if they have the time to invest in the project.

3) The percentage of market participants who are actually long-term buyers and holders of good quality securities has become a small minority of overall participants.

4) Some financial institutions and some households are drowning in the lending and borrowing sins they’ve committed over the last ten years.

5) Aspects of our stock picking discipline which have generated big advantages over long periods of time have temporarily been postponed by the worst bear market since the 1930’s.

6) The economy that follows the aftermath of this economic and stock market flood could be more pleasing because market participants will be more humble and less debt ridden. This reduces economic swings going forward and makes us all more vigilant of the behaviors which caused the problems in the first place.

Unlike us, Noah didn’t have 24 hour news coverage of his project and massive amounts of information on the outcome of current human behaviors multiplying on the internet. His critics probably started out numerable, but lost interest quickly and had very little power to sway public opinion. Besides, he looked nuts right from the beginning. Our critics grow more numerous as time goes on even though all recorded economic history shows that time is a great healer and investment results revert to the mean. We at SCM are looking forward to our rainbows in the stock market over the next five to ten years when we believe the doors will open to the “Next Great U.S. Stock Market”.

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.

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Dear Clients and Prospective Clients:

As the first four weeks of a powerful upswing in the stock market unfolds, we thought we would use a few moments of your time to ask a few questions.

1) What if the crowds of professional and individual investors are as wrong at extremes this time as they have been in the past?

2) What if the money in money market funds, CDs, savings accounts and T-bills all tries to come back into stocks at the same time?

3) What if Warren Buffett’s Oct 18, 2008 editorial about “Buy American, I Am” proves to be excellent advice?

4) What if the people who were smart enough to avoid some of the bear market on the way down never get back in on the way back up?

5) What if the fact that stocks dramatically outperform Treasury Bonds over long periods of time reasserts itself quickly?

6) What if buying and holding blue chips stocks works significantly better than trading in and out?

7) What if President Obama is the lucky man who leads our country as it successfully comes back from the worst economic contraction since the 1930’s?

8 ) What if gold, which has been trading exclusively on fear, goes down or nowhere for years?

9) What if everybody stops postponing the work they need to do on their home?

10) What if everyone who needs a new car buys one?

11) What if Starbuck’s coffee continues to be legal, addictive and tastes great?

12) What if the major Pharmaceutical companies sell more drugs in the future in China and India than they sell in the U.S.?

13) What if the people who sat through the worst stock market decline in 70 years are fully invested at the bottom and enjoy years of success because of it?

If you are underinvested in common stocks and/or are not investing with us, it is not too late to buy by any means!

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.

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Dear Clients and Prospective Clients:

Three years ago Americans were spending all of their after-tax paycheck and were borrowing above and beyond take-home pay to attain a certain standard of living. Most of the money came from loans against home equity or credit cards which were paid off by borrowing through home equity loans or mortgage refinancing. At Smead Capital Management, we think in terms of the U.S. going from a 104% spending society in 2006 to a 95% spending society today. Government statistics show that above and beyond our 401(k) or 403(b) contributions we are saving close to 5% of our after-tax paycheck. In less than a year we have reduced consumption at the household level by 9%. Since Household Consumption has made up 70% of Gross Domestic Product in recent years, this puts a 6.3% drag on the GDP comparisons beginning in early fall of 2008. Notice that the fourth quarter 2008 GDP figure was revised to -6.3%. This is very similar to our estimate of reset spending patterns.

All companies will need to deal with this reset of spending patterns. The U.S. automobile industry is having a very hard time with this reset because auto purchases are a big-ticket item. A $200 to $1000 per month payment doesn’t fit very well into the budgets of the newly reset households. People are holding on to cars for longer than nine years on average and auto repair businesses are flourishing. Auto industry experts talk about a sales level of 9 to 10 million vehicles sold in the U.S. in 2009 which is down from 15 to 16 million vehicles in 2006. It will take time for them to work through this reset as folks naturally err on the side of being overly conservative for awhile.

We like to think about who is being the least affected by the reset in spending patterns or who has put their companies the farthest ahead in adapting to the new patterns. We expect them to be the leaders of the “Next Great U.S. Stock Market” because we believe they will be maximizing their brand and balance sheet strength during the reset and will hit the ground running when we begin to grow from the reset spending levels. The loss of blockbuster drug revenue due to patents running out has forced Merck and Pfizer to flex their balance sheet muscle to buy Schering-Plough and Wyeth, respectively. People have reduced their doctor visits and cut back in healthcare, but it is much less than a 9% cutback. These companies get a huge part of their income from outside the country and the two most populated countries of China and India are becoming wealthy enough to demand the best in pharmaceutical products for the first time in their history.

Starbuck’s has adapted with a discount membership card, instant coffee and breakfast value meals. They’ve closed poor performing locations and cut corporate expenses. Walmart is grabbing market share as it reminds everyone to “Save Money, Live Better.” The folks who go to Walmart now, who used to think that they were above the fray, will add numerous spur of the moment purchases once the economy rebounds or stops contracting sometime later this year or early next year. Disney will control more and more eyeballs through ESPN, ABC and Disney Channel because people are staying home and watching more T.V. When advertising revenue rebounds, Disney will have gained market share. They will ultimately pick up customers from less well financed theme parks who fail or downsize as well as movie production companies that no longer get funded. Movie ticket sales are up 16% year over year as we escape to the theatres.

There are many more stories among our companies to tell associated with the new household consumption levels, but we believe our portfolios could take advantage of what the future brings despite this difficult transition from households hitting the spending reset button.

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.