Last night, I was sitting right here at my desk, typing away, my wife in the other room, talking to a friend on the phone. In an instant, we were suffocated by pure blackness. It was unusually sudden and complete. No flicker. No sigh of appliances winding down. Everything just stopped instantly and at once. I shut down my laptop, which was still running on its battery, and we felt our way to flashlights and candles.
While I sat in darkness, reading by flashlight and candlelight, my mind wandered to savage thoughts. What if someone kicked in my front door right now with a gun? What would I do? What could I do? What if this outage lasted 40 hours, not 40 minutes? I'd have a lot of spoiled food to deal with. It would cost a couple hundred dollars to replace it all. Not fun, but not a total disaster. We called Pacific Power. (Owned by Berkshire Hathaway, no less!) They predicted the power would come back in about three and a half hours.
The lights came back on 40 minutes later. Everything is fine... for now. I expect everything will remain fine, and we'll continue to have power outages each year during the busy months of July and August, when temperatures here routinely push into triple digits.
That's what would happen to our economy, too, if the government got out of the way and let the big banks fail. We'd be plunged into economic blackness. Our minds would wander to savage, fearful thoughts. We'd hunker down for years of misery. And it would be truly scary for a little while.
Then, much sooner than anyone expected, we would adapt and it would be over. The economic lights would come back on.
And we might not be staring down the barrel of more than $1 trillion of commercial real estate mortgage defaults between now and 2013. We wouldn't be sitting with our fingers in our ears, waiting for the U.S. dollar to detonate. We wouldn't be waiting for garbage stocks and garbage credits to crash back to reality. We might actually rid ourselves of the idea that government is bigger than the market.
We'd be just fine, in other words... if only Big Brother would get out of our way. Elbert Hubbard said, "Grown men don't need leaders." Amen.
But Big Brother gets more in the way every day. And hedge fund pioneer Michael Steinhardt is skeptical about the future of our economy. In a Bloomberg interview two months ago, Steinhardt said the trillions of dollars the government has already thrown at the problem won't solve anything:
We don't have the courage to really accept short-term pain... I'm not sure we accepted the tough things that might have had to be done to really reinvigorate the American economy.
Steinhardt doesn't see sustained gains for "a while," because he doesn't see a change in the consumer and housing is terrible.
Steinhardt also said people waiting for a mega-rally, which often occurs after a recession, should wake up... We've already seen "magical returns" in the past few months. He cited the amazing run-up in Bank of America's stock from $3 to $17 ($10 at the time of the interview). This is a great interview that I highly recommend watching (though it's almost 30 minutes long). Check it out here.
The fact that the market has mostly rallied since Steinhardt's interview makes his opinions more timely and prescient. And as evidenced by the past two days, the uptrend may have already broken.
Our own Jeff Clark has been short the market for the past two weeks, and if the past two down days of the market are any indicator, his thesis may finally be playing out. He has recently gone short several grossly overvalued companies – companies that have run up hundreds of percent in a very short timeframe.
If he's right about these stocks' intrinsic values, which are undoubtedly below today's levels, you could easily make a quick, triple-digit gain. To learn more about Jeff Clark's Short Report, click here...
Steinhardt and Clark are at odds with Traxis Partners' Barton Biggs. Biggs says we've got a big, fat recovery going and the S&P 500 has another 22% to go. Check that: Not 21%... not 23%... 22%. As if you could throw a dart from Earth and hit a bull's eye on the moon.
On September 15, 2008, with the S&P 500 just over 1,100, Biggs said, "I wouldn't be surprised... [to] find that the stock market is at its bottom about now." The market ultimately bottomed out another 39% lower at 666 in March 2009.
I suspect Biggs thinks the stock market discounts future events. It doesn't. The stock market merely reflects the opinions of its participants. What matters is the absolute price level, the amount of return you can expect. With the S&P 500 in rarified territory, around 24 times operating earnings, the most you can expect to make in stocks is about 4.17%... less than 30-year Treasuries, which pay a yield of about 4.55% these days.
Never buy stocks when they're more expensive than U.S. Treasuries. By the way, those World Dominators I mentioned? They're all trading at free-cash-flow yields of 5% and 6%... and unlike Treasuries, their yields grow with inflation.
On the opposite end of the spectrum, junk stocks (stocks below $5) have outperformed stocks above $50 (higher-quality stocks) more than they have in any speculative rally, according to Jeremy Grantham of Grantham, Mayo, Van Otterloo (www.gmo.com). Junk stocks have beaten quality stocks by 90.9% since March.
Thus do we witness the spectacle of junky little stocks like Diedrich Coffee, which is unable to make any money selling coffee, valued at 2.3 times sales and 14.6 times book value, up more than 11,000% off its March bottom...
... versus Procter & Gamble, the No. 1 consumer-products company in the world, with 23 billion-dollar brands and 18 $500 million-plus brands, which has raised its dividend every year for 53 years. Procter & Gamble is selling for less than 14 times next year's earnings estimate.
Sell junk. Buy quality. That's the only odds-on bet left in the stock market right now.
I've been recommending the best-quality businesses in the pages of Extreme Value for almost three years. Right now, five of these stocks are in buy territory. There aren't five other companies like them anywhere in the world. They are the largest, most-profitable companies in their industries. They are all No. 1. They're the most relentless dividend growers in the market, by far the best income equities you can own. They're World Dominators.
As for junk, I've got so many new junk stocks to sell short this month, I hardly know which one to pick. I'm leaning toward the one that's in the most misunderstood, overhyped industry today: housing. Housing is about to fall off another cliff, and the financial press keeps telling the world it's bottoming.
In an attempt to deal a major blow to the "create a free website to generate huge traffic in hopes of selling advertising" business model, media mogul and News Corp. Chairman Rupert Murdoch announced he will charge for all of his company's online content – which includes all Dow Jones publications and Fox News among many others.
I understand charging for Dow Jones content. It's always been viewed as premium content you can't get for free. We'll gladly continue to pay to access the Wall Street Journal and Barron's.
But if the free content/paid advertising model works... how on Earth could you expect to do anything but crash and burn by charging for content that's available elsewhere for the cost of an Internet connection? And let's face it, Fox News ain't the Wall Street Journal or Barron's. You could probably get a group of college kids together with some video equipment and create something of equal or better quality.
But what do I know? Murdoch isn't the only one singing this song. At a recent meeting, Financial Times Editor Lionel Barber said within 12 months all news agencies will be charging for access to their websites. Barber said the only question is whether they will charge per month, per article, or perhaps by both. The CEO of search engine ask.com said the "era of online content is coming to an end." And the New York Times is already planning a subscription-based model that would charge users $5 per month.
If Murdoch and others are right, Google could have a hard time of it. Google built its entire business around serving randomly generated Internet advertisements based on keywords embedded in a webpage.
I wonder if Murdoch's decision has anything to do with News Corp.'s recent quarterly report. News Corp.'s Fox Interactive Media took $630 million in impairments and restructuring charges. Fox Interactive owns MySpace, which News Corp. bought for $580 million... only to watch it stall out in midflight. MySpace has fired 700 employees and replaced co-founder Chris DeWolfe with Owen Van Natta from Facebook, which has overtaken MySpace.
So does the free content/paid advertising model really not work? Or is News Corp. just really bad at it? It wouldn't be the first time a good company made a horrible acquisition. That's the norm, in fact.
Fox's broadcast advertising isn't working, either. News Corp. President and COO Chase Carey told investors on a conference call, "On the broadcasting side, we have an ad-supported business model that does not work."
Rupert Murdoch has sure changed things and made a ton of money in the process... but that doesn't mean everything he touches turns to gold.
For the first time in 18 months, American Express saw credit trends improve among its cardholders, but the most creditworthy customers are still cutting spending... "While loss rates were better than we expected, they still remain high by historical standards," AmEx CEO Kenneth Chenault said. "The external challenges are not going to go away anytime soon."
The company expects to still write off an astounding 9.2% of loans in July – though that's down from 10% in the second quarter. The improvements spurred AmEx to spend more money on marketing, promotions, and customer acquisition.
Remember when members of Congress chastised the Big Three auto executives for flying to Washington on private jets? The message the government was sending to big business was clear... "You will not squander taxpayers' money." Congress didn't want big business wasting government money because, of course, that's their job... And the government hates competition.
In an ironic turn, the House just approved almost $200 million for the Air Force to buy three top-of-the-line Gulfstream 550 jets (at $65 million apiece) for transporting top government officials and congressmen.
Here's the catch, the Air Force only asked for one jet as part of a routine upgrade to its passenger air service, but the House Appropriations Committee took it upon themselves to add another $132 million to the Defense bill for two more jets to be stationed in Washington, D.C. Nobody can waste our money like the U.S. government.
New highs: AmeriGas Partners (APU), Novavax (NVAX), Addax Petroleum (AXC.TO), Eldorado Gold (EGO).
In the mailbag... Who's afraid of a little public health care? Maybe we should be... send your e-mails to: feedback@stansberryresearch.com.
"Dan, what is the difference between 'reported net income' and 'operating earnings'?" – Paid-up subscriber Rick Govern
Ferris comment: The operating income line is pretax, preinterest income. It's revenue minus cost of goods, D&A, and operating expenses. Net income is net of everything: taxes, interest, minority interest... everything.
Funny you should ask about this. A friend and I went back and forth in several e-mails last night about operating cash flow, free cash flow, and the true earnings power of a business.
To think about the true earnings power, just listen to Warren Buffett. When he talks about what a company is worth or what it earns, he'll always talk about pretax earnings. No businessman thinks of net income as what his business earns. That number is worthless... except as a reference that was never intended as the last word on a company's real earnings.
Like all financial statement numbers, it was intended as a reference point from which analysts could begin to assess a business. The modern idea about financial statements as vessels of truth is horribly flawed.
"I go to the local VA. It is fine. It is free. Your concerns about government take over of health care (a misnomer) are nothing but fear, and, as you know, we have nothing to fear... We desperately need a public option to bring competition into the sickness care industry. It works in every other advanced country. We rank 28th in the world in performance and first in expenditure. The for-profit insurance industry with its billion-dollar payouts to executives is a layer of cost that is not needed. We need a one payer system like Medicare or the VA." – Paid-up subscriber George Cheney
Ferris comment: Public options don't create more competition. They eliminate competition by seizing scarce resources. What you propose will have the efficiency of the Post Office and the compassion of the IRS.
The local VA is not free. You and I both pay for it through taxes, and I promise you that payment is much higher than the value of the service rendered. If the billion-dollar payouts you mention existed (they don't), they wouldn't be nearly as expensive as the layers of bureaucratic waste that have been added to health care in the U.S. over the last few decades. How many bureaucrats per caregiver do we have now? Is it 20? 30? 50? I can't keep up with it.
Obama's system will make health care more scarce by artificially lowering the price. Health care is no different than TV sets or sugar or vacations. If you subsidize the market, everyone will demand more, while simultaneously giving suppliers incentives to supply less. Waiting rooms will overflow – just like they do in every other country that does this. Suddenly, everyone will need an MRI. People like me, who have degenerative disc disease, won't be able to get one when we're so crippled by pain we can't stand up. Doctors will be overwhelmed and underpaid, and I'll have to leave the country in a vain attempt to keep the system from killing me and my family.
You say it works in every other advanced country. That's false. Socialized medicine is a disaster everywhere it's tried. I recently heard the mobs in waiting rooms in Sweden sometimes get violent enough that armed guards are necessary. I've spoken with Canadians who tell me their system is horribly flawed and corrupt. They just come to the U.S. I wonder where they'll go after people like you are done with U.S. health care?
We don't need a "one-payer" system – all that means is " government-controlled." Health care is not special. You screw it up, and you'll ruin the quality and lower the quantity available.
Nothing is free. You can't change that. People didn't make it that way. They found it that way, and that's the way it'll always be.
Regards,
Dan Ferris
Medford, Oregon
August 6, 2009