Wed, Jul 24, 2013|Sean Goldsmith

'Detroit aftershocks will be staggering'...

'Detroit aftershocks will be staggering'... Doc still likes 'munis'... How to know if you're a zombie... Caterpillar's bad numbers... Badiali updates us from Vancouver...

Meredith Whitney likes to make big calls...

Whitney, a well-known financial analyst, rose to fame after she correctly predicted Citigroup would cut its dividend prior to the subprime crisis.

Then in late 2010, she started warning investors about municipal bonds... She told CBS news program 60 Minutes we would see 50 to 100 sizable defaults in the municipal bond market that "will amount to hundreds of billions of dollars' worth of defaults."

In the six months following Whitney's comments, investors pulled nearly $50 billion from muni funds. But the biggest muni-bond fund – the Vanguard Intermediate-Term Tax-Exempt Fund – barely budged.

Dr. David "Doc" Eifrig never bought into Whitney's doom and gloom surrounding the muni-bond market... He recommended his first municipal-bond fund to Retirement Millionaire readers in October 2008. He kept readers in the position throughout the Whitney-inspired downturn. Today, readers are up nearly 70%.

But Whitney's prediction would have represented an unprecedented spike in defaults for muni bonds... normally viewed as one of the safest investments around. And of course, her wave of predicted bankruptcies never happened.

Following Detroit's bankruptcy, Whitney reappeared in the headlines, penning an article for the Financial Times, titled "Detroit Aftershocks Will Be Staggering." She argues Detroit's bankruptcy is just the beginning...

As jarring as the reality may be to accept, Detroit's decision last week to declare bankruptcy should not be regarded as a one-off in the U.S. municipal market – which is what the bond-peddlers are now telling their clients. The aftershocks of the largest municipal bankruptcy in U.S. history will be staggering, and Detroit will set important precedents.

Municipal bankruptcies have historically been rare for a number of reasons – including the states' determination to preserve their credit ratings, their access to cheap funding, and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance.

Forty-nine of 50 states are constitutionally required to balance their budgets. The main two ways municipalities plug the gap is through cutting back on government services and raising taxes. But in many of these states, cuts to pension benefits and debt service aren't allowed.

Whitney argues the cuts to public services drive down the desirability of a city, hurt real estate values, and eventually drive citizens out. It's the "negative feedback loop from hell," she says.

But she thinks city officials will begin "siding with residents" to save their cities... costing pensioners and bondholders pain.

I asked Doc for his latest thoughts on the muni market... And he still thinks Whitney's warnings are overblown...

My position is still the same... And the pricing of the muni bonds tells that as well. Detroit bonds traded down to 50 cents on the dollar, and they're back to around 70 cents on the dollar.

People knew Detroit was going bankrupt a long time ago... Detroit munis are trading at around the same levels as they were in the depths of the 2008-2009 recession.

Detroit's bankruptcy isn't that newsworthy other than from a social perspective... Cities will have to navigate these bankruptcies. Lots of public employees and unions cut deals where there was no oversight from the people whose taxes were going to pay them... There was a lot of cronyism.

As an investor, the question remains: Can these state municipalities pay you back? You have to be careful to stay away from places that have a bad reputation for managing their affairs and allowing outrageous pay and benefits.

The other major issue is that Detroit's mayor and the city's "emergency manager" Kevyn Orr are trying to turn Detroit's general obligation bonds (which are backed by the city's tax revenue) into unsecured debt... They're going after the untouchables in municipal bond finance. Up until the GM bankruptcy, when deals were struck with unions, federal bankruptcy court was clear that if you have secured debt, you're pretty much first in line.

It could set a dangerous precedent...

But I still think you have a great opportunity to buy munis today. And I particularly love them for high-income people (who benefit more from munis' tax-free yield). You can receive a taxable-equivalent income stream of 9%-10%. And the bond funds I've recommended have tiny positions in Detroit bonds, so there's been basically no effect in the portfolios.

As we said yesterday, Porter will address Detroit's bankruptcy in the Friday Digest... In the meantime, I'd encourage you to read Bill Bonner's thoughts on the "fallen city." Bill is the founder of Agora, our parent company... He also happens to be one of the finest financial writers in the world.

And he shares his thoughts every day in a letter called Diary of a Rogue Economist. Yesterday, Bill explained how "the zombies" brought down Detroit...

And here we offer a simple test so Dear Readers can tell which side they're on.

Ask yourself: In the absence of government, would people still willingly give you money to do what you do? If the answer is no, you are probably a zombie.

To gain access to the essay and to sign up to receive Bill's daily missives for free, click here...

Global economic bellwether Caterpillar announced disappointing second-quarter earnings today... The world's largest construction and mining-equipment company said earnings fell 43% to $960 million in the quarter. Revenue fell 15.8% to $14.63 billion. The company said dealers cut inventories by $1 billion as China's growth slowed.

Caterpillar also cut its earnings and revenue guidance for the year. The stock fell as much as 2.8% on the news. CEO Doug Oberhelman said in a statement...

Overall end-user demand is similar to our previous outlook, but we now expect a more significant reduction in dealer machine inventory. That's the main reason for the reduction in the sales and revenues outlook. During the second quarter, dealers increased their utilization of inventory from our product distribution centers, which allows them to meet customer demand with less inventory.

With the sharp reduction in dealer inventory and the decline in mining, 2013 is turning out to be a tough year and we've already taken action to reduce costs.

During the first half of the year, we've had temporary factory shutdowns, rolling layoffs throughout much of the company, reductions in our flexible workforce,

and we've reduced discretionary and program costs. While we've taken significant action already, we will be taking additional cost reduction measures in the second half of 2013.

Last week, we told you Caterpillar was the latest short-sale target for famed short-seller Jim Chanos.

Chanos, founder of the short-only hedge fund Kynikos Associates, said Caterpillar would decline more than expected as Chinese growth slows...

Iconic American company, leader in its class, but tied to the wrong products at the wrong time in the cycle. The bulls expect a [capital expenditures] decline in mining. But here's the problem: They expect it to decline slowly.

Chanos said capital spending on mining equipment is far above the historical average because of the Chinese real estate bubble. And he said a Chinese slowdown and the end of "the global commodities supercycle" will push spending down... which will crush Caterpillar.

S&A Resource Report editor Matt Badiali sent us an update from the Agora Financial conference in Vancouver...

According to an analyst that resource investing legend Rick Rule cited, there are 800 stocks on the Toronto Stock Exchange or Venture Index with less than $200,000 in the treasury today. That is not enough to remain in business. I've written about how these companies were going to go out of business. The problem is, it's a slow death.

But it is coming. There are no buyers today. Rick said the boutique hedge funds are all gone. The resource mutual funds are still selling what they can to cover redemptions. And the mining companies are still unwinding the $75 billion in bad acquisitions that they made over the last decade. I've heard rumors of massive layoffs, mayhem, and panic.

In the February 5 Digest Premium, Porter told readers he'd buy shares of consumer-electronics giant Apple if it dropped to $400 a share. At the time, the stock was trading above $450. And in April, shares fell below $400. Porter noted it was safe to buy.

Yesterday, the company announced earnings and revenue numbers that beat Wall Street expectations. (Apple's earnings actually fell 22% for the quarter.) The biggest surprise was iPhone sales... The company sold 31.2 million phones, up 20% from a year ago.

Shares jumped nearly 6% on the news. They're up nearly 14% since bottoming in April.

New 52-week highs (as of 7/23/13): Consolidated Tomoka (CTO), CVS Caremark (CVS), Chevron (CVX), Hershey (HSY), Johnson & Johnson (JNJ), ProShares Ultra KBW Regional Banking Fund (KRU), 3M (MMM), RPM International (RPM), Target (TGT), and ExxonMobil (XOM).

More cheerful e-mail in today's mailbag. Send your notes – good or bad – to feedback@stansberryresearch.com.

"Just read through the first of your S&A Digest. You come through as honest and down to earth. I like that! Today's my first day on the subscription – looking forward to the info and insight." – Paid-up subscriber Al P.

Porter comment: Welcome aboard!

Regards,

Sean Goldsmith

Delray Beach, Florida

July 24, 2013

Earlier this month, politicians in D.C. passed the Living Wage Law, which mandates big business pays its employees at least $12.50 an hour... a significant increase from the current $7.25 federal minimum wage rate. (It's only applicable to retailers with sales of $1 billion or more.)

Wal-Mart, the world's largest retailer, said it would leave Washington, D.C. if the law passed. And lawmakers put Wal-Mart to the test...

D.C. City Councilman Vincent Orange, a lead proponent of the legislation, said, "The question here is a living wage. It's not whether Wal-Mart comes or stays... We're at a point where we don't need retailers. Retailers need us."

In response, Wal-Mart said it would abandon plans to build three stores in the area and "review the financial and legal implications" of not opening them.

This is typical... The people in government believe they can mandate income or wages. But you can't force an employer to raise its wages without offering some sort of incentive.

By the way, this is the same problem as the health care law. The government has decided everyone has a right to health care... but the government can't provide it. A doctor and a hospital have to provide it.

And the doctor and hospital have to receive some kind of incentive to do so. So the idea that you can dictate these benefits is always going to be flawed.

This kind of legislation will fail. And it doesn't provide any benefit to D.C. residents... It doesn't get them higher wages. It simply reduces the opportunity to get a job at all.

– Porter Stansberry with Sean Goldsmith

How D.C. lawmakers are trying to screw Wal-Mart...

D.C. lawmakers recently passed a law requiring large retailers to pay a higher hourly wage to its workers. Wal-Mart, the world's largest retailer, said it would exit D.C. in response.

In today's Digest Premium, Porter shares his thoughts on this government boondoggle...

To continue reading, scroll down or click here.

How D.C. lawmakers are trying to screw Wal-Mart...

D.C. lawmakers recently passed a law requiring large retailers to pay a higher hourly wage to its workers. Wal-Mart, the world's largest retailer, said it would exit D.C. in response.

In today's Digest Premium, Porter shares his thoughts on this government boondoggle...

To subscribe to Digest Premium and access today's analysis, click here.