William Smead's  Instablog

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Dear Fellow Investors:

Thanksgiving break I read a book by Professor Thomas Sowell titled "A Conflict of Visions". He explains that most of the political and economic debates of the last three hundred years come down to two conflicting underlying visions of how we should operate. Understanding these visions could tell us at Smead Capital Management and you as investors where we could be going over the coming years in the markets.

Sowell sees people accepting either a constrained or unconstrained vision of the future. Adam Smith's "Invisible hand" and "laissez-fair economics" were poster children for the constrained vision. Constrained visionaries believe in respecting systems, processes and repeated history to bring moral outcomes. They believe each person acting in their own self interest will create the most public and social good.

Unconstrained visionaries believe that as human beings advance intellectually, they should expose an enlightened minority who can lead. Their leadership should have sincerity and a moral vision to benefit everyone. The unconstrained vision is best exemplified by William Godwin's "Enquiry Concerning Political Justice". To Godwin, man's understanding and disposition were capable of intentionally creating social benefits. Godwin regarded the "intention" to benefit others as being "of the essence of virtue".

Much of the debate and nervousness surrounding our current markets can be tied to these conflicting visions. Policymakers have used numerous Keynesian (Unconstrained) economic policy maneuvers to intervene in the markets the last 15 months. Enlightened economists seriously doubt the constrained view that individuals acting in the marketplace on their own self interest will heal our economy. Conservative (Constrained) economists believe lower home prices, stock prices, low interest rates and abundant cheap labor are ingredients for a long lasting recovery.

Therefore, both visions are at work and those who don't agree with the opposition vision seem to believe we are going "into Hell in a hand basket". Tea Party folks are scared to death of heavy-handed government intervention. Those with the unconstrained view fear that residential real estate markets and the lending institutions crippled by their weakness can't heal themselves. They are willing to pay the price down the road for running huge government deficits. They feel that this is a once in a lifetime opportunity to use the economic difficulty to get us headed down the right path for the future. Both visions are attracted to the emerging markets and commodities like gold and oil. Adam Smith fans (constrained) can see the "invisible hand" in worldwide growth and Godwin’s Backers (unconstrained) love the "enlightened" feeling they get from being cutting edge worldwide investors. Unfortunately, it looks much like the 1998 tech stock cutting edge to us.

Investors in common stocks have put premiums on those sectors which appear to have the most to gain from the unconstrained or enlightened view of the future. We must admit we like the idea that the companies which operate with the best systems, processes and have the best histories will provide the most future success for the least amount of capital. Our view assumes that enlightened reason almost always comes at too high a price and doesn't work often enough to generate market beating returns.

It took me the first ten years in the investment business to learn to get away from investing by trying to predict the future and assuming that humans are getting better as they get more sophisticated. We want to rely on owning great companies for long-term holding periods and let both of the conflicting visions fall where they may.

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 Fellow Investors:

On November 13th, CNBC writer Jeff Cox shared the findings of a recent survey of major institutional investors put out by Bank of America/Merrill Lynch. These 111 institutional advisors have over $1 trillion in assets under management. Cox wrote, “Even as the US market continues to rally, many institutional investors are trimming their US holdings and putting more money into foreign stocks - especially those in emerging markets.” The primary motivator is a belief among these advisors that economic growth in the US will be anemic going forward. Here is a representative quote from one of the advisors surveyed: "We found a tremendous strategic desire to move away from US equities, particularly large-cap, and toward a more global mandate," analyst John Haugh wrote in a research note. "Emerging market equities are the most desirable asset class over the next 12 months, with 42% looking to add/increase investment."

The day before (Nov. 12th), CNBC aired an interview session conducted by Becky Quick at the Columbia Business School where students and faculty asked Bill Gates and Warren Buffett a series of questions. These questions ranged from career advice to visions of the future. In the opinion of those of us at Smead Capital Management, the most important question of the night went to Mr. Buffett as a follow up question from Becky Quick. The student had asked for Buffett’s opinion on the believability of this rally coming off the March lows given that a number of respected market participants were cautious. Buffett reminded everyone in the audience and on television that the best market year of his 67 years in the stock market was 1954. It was a recession year which saw unemployment double and yet saw a 50% gain counting dividends.

Becky followed up by asking about his recent purchases of a company in Israel and in China. She asked, “Are there more opportunities overseas or here in the US?” Buffett’s answer was short and sweet. He said, “I see more opportunity in the United States. We're the biggest economy and we're looking for big deals. But I am delighted to find something, you know, whether it's in China or whether it's in Israel, like Iscar, or whatever it may be. There are more opportunities in the United States than anyplace else.”

Buffett was not just whistling Dixie with his answer. He had spent $26 billion buying the rest of Burlington Northern the week before and was quoted as saying, “Most important of all, however, it’s an all-in wager on the economic future of the United States,” said Mr. Buffett. “I love these bets.” On November 16th we had learned that Berkshire Hathaway had doubled its position in Walmart and increased its position in Wells Fargo among net stock purchases of $2.3 billion. You probably don’t load your portfolio with the nation’s largest retailer and one of the nation’s biggest real estate lenders if you believe in an “anemic economic recovery”. We don’t know about you, but we have a choice of who we are going to take our economic prognostications from. Is it going to be Warren Buffett, who gets to see and understand as wide a swath of diverse businesses as the Chairman/CEO of one of our nation’s largest conglomerates? Or will it be far less experienced, far less successful and far less informed economic prognosticators who could be a part of a crowded trade?

All this does is make us that much more excited to own our portfolio of Large Cap Value US stocks and continue to enjoy what we believe to be a multi-year and very powerful bull 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.

Long: WMT WFC

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Dear Fellow Investors:

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

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

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

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

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

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

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

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

Best Wishes,

William Smead

The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. The securities identified and described in this missive do not represent all of the securities purchased or recommended for our clients. It should not be assumed that investing in these securities was or will be profitable. A list of all recommendations made by Smead Capital Management with in the past twelve month period is available upon request.

Long: BRK-B