Happy two-year anniversary... Why World Dominators are a 'buy' today... Another Buffett story... How to make $2.54 billion... Commercial real estate getting popular... A global bank warns of U.K. food riots...
The current bull market reached its two-year anniversary today... On March 9, 2009, the market hit the point of maximum pessimism. Stocks were down around 60% from 18 months prior (and had fallen for six straight months). People thought the world was coming to an end. At the very least, they thought the stock market would never return to its previous highs... And "buy and hold" investing was dead.
But as our friend, and brilliant resource investor, Rick Rule likes to say, "You're either a contrarian or a victim." The world didn't come to an end (thanks to a several-trillion-dollar gift from the government). And buyers in early 2009 made a fortune. Financial stocks, which led all sectors in declines, bounced the highest to date... up 169%, followed by consumer discretionary and industrial stocks, which rose 145% and 141%, respectively. Take a look at this graphic from CNBC, showing the five best and worst performers in the S&P, Dow, and Nasdaq. It's investment candy...
Dan Ferris did a similar study in his latest issue of Extreme Value. He wanted to see how his World Dominators have performed since March 2009. Here are his findings:
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The biggest rebound since the markets bottomed out in March 2009 has been in the massive, manic rebound in risk-seeking financial behavior: the rebound in speculation. Since March 2009, the smallest 10% of U.S. stocks by market cap has risen 154%. Today, those stocks trade at an average of more than 41 times earnings. Junk stocks and junk debt have performed alike. In 2009, junk bonds soared 57.5%, and rose another 15.2% in 2010. The average junk bond now sells for the princely sum of $1.0389 per $1 of face value. Record-high junk bond prices mean record-low investor compensation (i.e. record-low junk bond yields). According to the Merrill Lynch High Yield Master II junk bond index, junk bond yields recently hit a new record low of 6.837%. Junk bond spreads over Treasurys (which are risky enough!), have compressed substantially, falling from 6.2% in December to about 4.5% today.
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Markets have short memories. Just two years after the greatest financial disaster in nearly 80 years, investors are again clamoring for yield (aka "risk"). Small-cap stocks (which perform best when investors stretch for returns) are soaring. And how are Dan's beloved World Dominators doing? To find out, Dan used the Russell 3000 (which contains the 3,000 largest U.S. companies) to see if large-cap stocks were still cheap relative to small caps. He compared the smallest 10% by market cap of the Russell 3000 to the largest 10%. His findings:
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Clearly, in 2009, small-cap stocks ruled. The smallest stocks in the market rose 74% in 2009. The trend was confirmed. Like most confirmations, it was merely a sign that the end was near. The largest 10% of the market took over in 2010, more than doubling the total return of the smallest 10%. If you want to know what sort of returns you can expect from each group, just turn the P/E ratios upside down. The largest 10% has an earnings yield of 4.44%, while the smallest 10% promises an earnings yield of just 2.4%. Neither is anything to write home about, but the difference is primarily what we're interested in here, and big stocks are paying you almost double what small stocks are. Dividend yields confirm this, with the small stocks paying about 1%, and the large stocks paying just shy of 2%. The torrid two-year rally in the smallest, riskiest stocks is history – it's a thing of the past. It started running out of steam last year. We're barely into March, and it's already notably weaker.
– Dan Ferris, March 2011 issue of Extreme Value |
In other words, Dan's World Dominators are a screaming "buy." We believe the big stock market gains were made in the past two years. The winners for the next few years will be high-quality U.S. stocks and hold. You will get rich by compounding. It's not sexy. But it is the surest way to get wealthy in stocks. If you're not convinced, re-read the bit about Coca-Cola from Warren Buffett's latest investment letter:
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Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn't be surprised to see our share of Coke's annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business. |
I spoke with the former head of research at a major East Coast investment bank yesterday. He was involved in the initial public offerings of Microsoft's and Starbucks' stock. He's been in the business for a long time. (He currently manages funds for family offices.) We discussed "boring" buy-and-hold investing... particularly Buffett's latest letter. He's followed Buffett since "the Oracle of Omaha" was a nobody. He told me a story (a firsthand account) about compounding...
When Buffett was brand new to investing, he was bidding for an oil company against Walt Helmerich (the founder of oil driller Helmerich & Payne). Neither man let down. But they knew bidding the stock too high wouldn't benefit either of them... So they flipped a coin for the company. Buffett won.
After the victory, Buffett told Helmerich, "Why don't you take the $500,000 you were going to bid on the company and give it to me... I'm a pretty good investor."
"I'm pretty good, too... I think I'll take my chances," Helmerich replied.
Everybody knows the early investors in Berkshire Hathaway (Buffett's holding company) got rich... Each share they bought is now worth almost $130,000. But what would Walt Helmerich's $500,000 be worth today if he'd have given it to Buffett?
Using the increase in Berkshire Hathaway's share price since Buffett took over in 1965, that $500,000 would be worth more than $4 billion today.
It's a fun story, but the point is, buying high-quality stocks that treat shareholders well – and never selling – will make you rich. You'd be foolish to pass up Dan's World Dominator portfolio. To sign up for Extreme Value and access Dan's World Dominators (six of them are currently buys), click here...
In yesterday's Digest, Dan said, "Great investors usually make bearish comments prior to the top, but not at the top." He cited hedge-fund manager Seth Klarman returning 5% of investors' money last November because his "opportunity set" was smaller in relation to his cash hoard. He also notes the July 1999 warning Buffett gave about stocks at the Sun Valley, Idaho conference.
While he may be wary of the larger market, Klarman is finding value in high-quality commercial real estate. We noted he made a $300 million equity investment in Streets of Buckhead development in Atlanta, Georgia. And Porter's on the same page. From the February 25 Digest:
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I've greatly increased – more than doubled – my exposure to real estate. I've been buying cheap apartment buildings in south Florida out of foreclosure. I've been buying unique, trophy real estate there, too. I think the middle of the market is still going to fall a lot... But the top end and the bottom end represent an outstanding value – one of the best opportunities of my life.
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And KKR, one of the country's largest private-equity firms, agrees... The firm announced yesterday it hired Ralph Rosenberg (a former Goldman executive) as the head of its global real estate team. KKR's larger competitor, Blackstone, is already focused on commercial real estate... Last month, the company announced a 56% jump in quarterly profits. The increase was largely from profits in the real estate division (namely its purchase of Hilton Hotels).
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New 52-week highs (as of 3/8/2011): Virginia Gold Mines (VGQ.TO), DirecTV (DTV), Automatic Data Processing (ADP), Hershey (HSY), HMS Holdings (HMSY), Molina Healthcare (MOH), Cytori Therapeutics (CYTX), Barnes & Noble (BKS), Philip Morris International (PM).
In today's mailbag, someone who gets our tax proposal, and… surprise, surprise… someone who doesn't. To learn about our Project to Restore America, click here. And send us your feedback here: feedback@stansberryresearch.com.
"As Porter suggested, i forwarded Friday's Digest to various people, and posted part of it on Facebook (attributing Porter). The only responses i got were from people like your subscriber, Michael Diamond, who gets his data from such clarion sources as Michael Moore. Please explain to him that it is important to consider the source, rather than swallowing whatever nonsense a movie star is spewing; regurgitating it after swallowing is even more vile.
"The salary i receive from my day job is over $80K, but i talked my employer into allowing me to take a pay cut by working only 80% of the time (so $64K), when i realized i was spending so much time working that i didn't have time to make real money. But i haven't paid any taxes in 6 or 7 years because of having tax shelters. This is despite the fact that i have a much more substantial income from outside my day job – but it's all sheltered, and produces additional sheltering for my salary. I will exploit whatever loopholes there are in the tax code, as anyone should do, but i am very uncomfortable about receiving all these benefits from the government without paying anything. (I support my community and various charities with both my time and money, though.)
"Porter's idea would generate tremendous income from the 'rich,' but Mr. Diamond's suggestion would simply create a lot of expats. Why would someone stay in a country that insisted on taking 50% of their income? And how can anyone feel justified in the government stealing the wealth of its most productive citizens? If i were to leave, it would be the end of a job for all of my employees.
"The only salvation available to our nation is to stop the spending. We need to drastically cut back on all of the good things we spend money on, and eliminate spending on the bad things. There should be nothing sacrosanct. The issue is our survival as a nation. The best case scenario if we do not make horrific cuts is hyperinflation that will destroy the wealth of the entire middle class (not the poor; they have no wealth. And not the rich, because they are sheltered from inflation just like they are from taxes!) [BTW, if you aren't sheltered at least somewhat, you have no excuse as a reader of the S&A publications!]
"Mr. Diamond's solution is to try to get enough money from the rich to be able to continue our profligate ways. The problem is, even if the rich suddenly got stupid and decided to stay in America after the government decided to tax not 50%, but 100%, there still would not be enough money to pay. But increasing taxes as Mr. Diamond suggests would surely only serve to diminish the amount of money our government was able to collect; that is what always happens wherever such 'progressive' schemes are implemented.
"My fear is that there will be too many people who love the spending more than they love America. There has not been any shortage of people (even left leaning politicians) who have declared our financial condition as a nation to be 'unsustainable.' Unfortunately, many Americans do not seem to realize that the implications of that word mean that our nation cannot survive if we do not change our ways.
"Porter's 20% tax system would undoubtedly increase our government's income. Michael Diamond's would merely hasten our demise. But without radically diminishing everybody's favorite forms of government spending (welfare on the left, warfare on the right, education, health, etc.), there will be no America left." – Paid-up subscriber Tim
"In our view, it's critical everyone pay the same rate of taxation and all forms of tax shelters be eliminated.
"Oh yes, the rich man's dream... my taxes which are not onerous now, would greatly decrease while my grandson's taxes, (he's just out of college and doesn't earn much), would greatly increase.
"Your whole staff is such a bunch of little rich boys... you just keep harping and harping and harping on 'the poor rich man,' the 'poor corporattion.'" – Paid-up subscriber Lorin Baker
Porter comment: That's just not so.
It's a false illusion that taxes on earned income (today's so-called income tax) capture the rich. They don't. You can shelter your income in lots of ways so that you don't pay any tax at all.
Our plan is to eliminate all these shelters by taxing all income, of any type. By getting the rich to pay their fair share... and getting the poor to pay something... I believe we'll end up with a government that's more responsive and more efficient, because suddenly, everyone – rich and poor – will have something at stake.
A $24,000 exemption would mean that if your grandson, just out of college, is earning say $35,000 per year, he'd have to pay 20% of $11,000. That's a total tax bill – state, local, and federal of only $2,200. That's probably less than what he'll have to pay right now, depending on where he lives.
Good investing,
Sean Goldsmith and Porter Stansberry
Baltimore, Maryland
March 9, 2011