I had lunch with Whitney Tilson today. Whitney is a hedge-fund/mutual-fund manager with a very good track record – roughly double the S&P 500's return since inception 10 years ago. While I have reservations about the fee structures of all mutual funds and hedge funds, if you're going to put money in these sorts of things, Whitney is the kind of manager you want. He is scrupulously honest. And he is a great analyst.
Whitney, if you didn't know, has been the "axe" on the mortgage meltdown. He called it first. He called it best. And he has done the most thinking on the subject. What is he saying now about home prices and bank solvency?
If you want to know all there is to know about it, you might buy a copy of his new book – More Mortgage Meltdown. I've only scanned through the book (which he gave me at lunch), but it looks like a great read – a solid primer on how to be a thorough bottom-up investor.
Or... you could take the lazy man's route to knowledge and just look at what Whitney owns now in his portfolio. Answer? Wells Fargo and American Express. Thus, you'd know the worst is probably over in the mortgage business. I asked Whitney why he thought so. Here's a paraphrase of what he told me...
Most people don't understand that losses aren't usually catastrophic to banks – not even big losses. The problem with the subprime losses, which wiped out dozens of financial institutions and blew up dozens of big hedge funds, was that the subprime loans were securitized. This meant they were marked to market each day, as investors bought and sold them. Thus, instead of seeing losses in subprime homes show up over the course of several years, they showed up instantly. Very few financial firms could generate enough income fast enough to survive this immediate hit to their balance sheets.
What will be different about the coming losses in prime loans and commercial real estate is that the losses will accumulate over a very long period of time. So, even though there are more losses coming, banks should be able to compensate for these losses with additional revenue. Just look at Wells Fargo's last quarter. Sure, they took some big hits on their mortgage book... but they countered these losses with record revenues...
There's one thing, though, I think Whitney is missing: Where are the big bank revenues coming from? What's happening is plain to see, if anyone cares enough to look... The Fed is manipulating interest rates in a way that's designed to repair bank balance sheets. Short-term interest rates (from which banks fund their operations) are nearly zero. One-year T-bills are only yielding 0.35%. Meanwhile, 30-year fixed mortgage rates are around 5% – resulting in a "mortgage spread" of nearly 4.5%. That's the perfect recipe for banking profits.
The Fed is even buying lots of mortgages and Treasury bonds to make sure long-term interest rates won't move up and discourage anyone from buying a house. In short, it's the ideal environment for both the housing market and for banking. The government's idea for fixing the credit bubble of 1996-2006 seems to be simply manufacturing a new one.
I don't think it will work. There's a fly in the government's ointment, and that fly is inflation. But Whitney didn't even consider the risk. Instead, he put up a chart showing the impact of interest rates on stock market multiples. What happens to the stock market during periods of low interest rates? Obviously, when interest rates are low – like they are right now – stocks normally do pretty well, because there's no better way to make money.
But then I asked him the key question:
Whitney... Excuse me... I see your chart comparing interest rates and stock market valuation goes back all the way to 1888. But... we didn't have a paper dollar standard until 1971. And following that change, we didn't have any legal way to own gold until January 1, 1975. Since then, as you know, we've always had the risk of negative real interest rates. What happens to stock markets when real interest rates are negative?
Whitney said he'd never looked at the numbers, but he didn't think it mattered all that much, because "interest rates are interest rates." Yikes. Er... sorry, Whitney... but nominal rates don't matter much at all. What matters are real interest rates.
Nobody, for example, wants to buy a banana republic's bonds – even if it's paying 20% – when inflation in the country is running at 50% annually. Doing so will cost you 30% of your money in one year. And... the same thing is now happening in America.
Let me explain... There are lots of ways of measuring inflation. The worst way – looking merely at consumer prices (CPI) – is what the government does. The best way is by looking at the size of the Federal Reserve monetary base. This shows you how much money is being created out of thin air.
The monetary base has basically doubled over the last year. But if you throw in all of the various guarantees the Fed is responsible for, the real size of the balance sheet has grown by a factor of 10. (The Fed is now guaranteeing more than $11 trillion of debt.) Folks who believe inflation is only measured by the CPI are about to learn an expensive lesson.
How do I measure inflation? Simple – just watch the price of gold. Gold is the free market's money. The U.S. dollar is the world's reserve currency – the government's money. You can either participate in the government-led economy (by holding dollar-denominated assets) or you can keep your savings in the free market (by holding gold).
Normally, you get paid to participate in the government-led racket – because doing so is risky, governments always default eventually. Meanwhile, gold doesn't pay a cent. Nor does it ever default.
So I believe the best way to figure out the real rate of interest on U.S. dollars is simply by measuring the change in the price of gold compared to the interest paid on U.S. Treasury notes, bills, and bonds. For example, this year, the price of gold is up roughly 20%. Meanwhile, a 10-year T-bond is paying roughly 3.5%. By lending the U.S. government money for 10 years, you would have lost roughly 16.5% of the intrinsic value (the purchasing power) of your savings. Not a very good deal.
The key question for stock market investors these days is: What really happens to stock prices during a period of negative real interest rates? It isn't pretty, my friends. Stocks generally trade at earnings multiples under 10 during periods of negative real interest rates. That's the bad news. The good news, though, is some companies do particularly well during periods of inflation and negative real interest rates.
The trick, then, is knowing how to invest during periods like the kind we're in right now. I know someone who does: Warren Buffett.
In April of this year, I explained this same thesis – that inflation was coming and that to survive, we would have to move into segments of the market that perform well during periods of negative real interest rates. I told my readers to buy three stocks in particular – three companies that own irreplaceable assets in the United States and whose debts were denominated in U.S. dollars.
Burlington Northern was one of these three stocks. As you know, Buffett seems to agree with me. He offered $100 per share for the whole company. We paid $65. That's a 53% return in six months. But you know what... I'm sorry to see the deal happen. It's not because I don't like making a huge return so quickly. It's because I know Buffett is right: Burlington is a phenomenal asset to own. Over the next 10 years, the value of its debts will be wiped out by inflation (negative real interest rates), while the dollar value of its irreplaceable assets will soar.
Take a look at this chart. It shows the price of Burlington Northern as measured in gold. Both gold and shares of Burlington Northern are ways of protecting yourself against inflation. And when we bought the stock in April, Burlington had never been cheaper compared to gold.
I guarantee you this is one of the main reasons Buffett bought the stock. At its current price, Burlington is better than gold.
What were the other two stocks I recommended in April – stocks perfectly designed to prosper during periods of high inflation and negative real interest rates? My subscribers know. And so should you. A year-long subscription to my newsletter costs less than one night out for two at a good restaurant. Or less than one bottle of good wine. My April issue alone is worth more. Just sign up already.
"It's clear Mr. Roubini hasn't done his homework, yet again," Jim Rogers told Bloomberg. Nouriel Roubini (the NYU economics profess dubbed "Dr. Doom") claims bubbles are forming in gold and emerging-market stocks. To refute Roubini, Rogers said commodity and emerging-market stocks are still down from their historical highs by at least 50%...
It's not a bubble if something is up 100 percent this year, but down 70 percent from its high. That's not a bubble, that's a good year. That's a great year. Maybe it's too high for this year, but that's not a bubble.
Rogers still isn't buying any stocks, but he's considering buying more gold, which he believes will hit at least $2,000 an ounce (based on the inflation-adjusted high of just over $2,000 in 1980) once the bull market in the yellow metal ends. However, he says gold could go "much, much higher." And Rogers still believes we've hit the point of maximum pessimism with the U.S. dollar, and the beaten-down currency should rally.
Our own Jeff Clark agrees with Rogers' thesis on the dollar, and he's currently formulating a super low-risk trade to take advantage of the dollar's upswing. However, one of Jeff's most reliable market indicators says stocks are due for a plunge. He's waiting for the S&P to hit a certain point – tripping his indicator – then he's going short, and big...
Acting on Jeff's trade could easily double your money in one week. There's still time to sign up for the S&A Short Report before Jeff releases his newest trades. To learn more, click here.
Make sure to read Steve Sjuggerud's latest special report for True Wealth readers... He's discovered a perfectly legal, little-known way to eliminate Social Security taxes. According to a study by Wharton (one of the world's finest business schools), using this strategy could save you more than $100,000 over a 30-year period.
The report includes six other secrets that could all make and/or save you tens of thousands of dollars every year. Not everyone will qualify for this money, and there are certain requirements, but if only one of these scenarios applies to you, you could immediately see thousands extra in your bank account. To receive this special report, click here.
New highs: Burlington Northern Santa Fe (BNI), Visa (V), Sprott Resources (SCP.TO), Jinshan (JIN.TO).
In the mailbag... Believe it or not, still more BSX bashing. When will it end? What's your score card of my stock picks look like, dear subscribers? Have I gotten anything right yet? Send it here: feedback@stansberryresearch.com.
"BSX is getting killed! Why! Horrible call." – Paid-up subscriber MJ
Porter comment: Now, look, you can't blame me (or credit me) for a stock's performance after we've recommended you sell it. If you didn't see our detailed analysis of what went wrong and why we recommended selling the stock, see last month's Digests. We've taken a 12% loss on BSX. We have moved on.
Keep in mind, the other dozen or so stocks I've recommended over the last year are nearly all up – including gains of 67%, 46%, 25%, and 19% on my best ideas to protect yourself from inflation. That doesn't include the 43% gain we just took on Bronco Drilling, which was recommended in September. We're up 55% on a REIT fund, after I reversed my bearish position on REITs at the bottom. We've even made money on high-yield bonds (18%) and shorting government bonds (16%). And everyone who reads my newsletter had the opportunity to buy Buffett's new railroad for about two-thirds of the price he just paid!
Obviously, nobody gets every single thing right when it comes to picking stocks. And I certainly got it wrong on BSX. But it's strange to me that in the midst of one of the best years ever in my career as a stock picker, the only stock my readers actually bought was the only bad pick I've made. Come on, folks, help me out here...
"A couple of days ago Porter was taking Doc to task over having said that inflation has not started yet. I have to agree with Doc. At my level of existence things like gas and groceries are cheaper than they were. Until prices of the things I buy in my daily life go up I don't consider it inflation..." – Paid-up subscriber Dave
Porter comment: Like I told Doc... Good luck with those ideas. By the time the inflation that's happening right now hits the CPI or retail prices in general, it will be far too late to preserve the purchasing power of your savings.
"You are often too much about my boat, my house, my talent, etc for my liking, but sometimes you do come up with something commendable and brave. My hat's off to you about the way you held your nerve and talked about the race thing. Whether you're a racist or not I wouldn't know, but to suggest your piece about Detroit makes you one is ridiculous. But the reaction certainly was predictable..." – Paid-up subscriber Eben van der Westhuizen
Porter comment: Keep your eyes on Atlanta's mayoral elections. There's a run-off between a fiscally conservative, Democratic woman (Mary Norwood) and a liberal black Democratic man (Kasim Reed). Reed has the support of the traditional black voting bloc and has campaigned explicitly on race. Mary Norwood has been campaigning with a promise of better, smaller, and cheaper government. In a city that's 60% black, Norwood captured 45% of the vote. Can she win in a run-off against a black opponent? If so, it would signal a new era of politics in Atlanta and the end of the black political machine.
"I live in a town within an hour of the Canadian border and recently traveled there to open a bank account which I was told must be done in person if a US citizen. Upon re-entering the States I was given the third degree by a US Customs officer about my business activities resulting in a brief detention complete with a detailed vehicle search, minor further questioning and TSA background check. These people were all business... jackbooted and armed. Being that I was clean and lawful I was back on my way quickly. All this for just opening a foreign bank account with verifiable funds via a bank draft. The writing is on the wall. You have advised me well Porter...thank you!" – Anonymous
Porter comment: Just wait. By the time OBAMA! leaves office, you won't be allowed to have a foreign bank account, you won't be allowed to take gold out of the country, and you won't be allowed to exchange dollars for foreign currencies, except on a small scale as required for travel.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
November 4, 2009
Lunch with Whitney Tilson... Why the worst of the mortgage bust is over... Risks to the government's plan... How to prosper during inflation... BNI vs. gold... Roubini hasn't done his homework... Still more BSX bashing... Atlanta's mayoral elections...
I had lunch with Whitney Tilson today. Whitney is a hedge-fund/mutual-fund manager with a very good track record – roughly double the S&P 500's return since inception 10 years ago. While I have reservations about the fee structures of all mutual funds and hedge funds, if you're going to put money in these sorts of things, Whitney is the kind of manager you want. He is scrupulously honest. And he is a great analyst.
Whitney, if you didn't know, has been the "axe" on the mortgage meltdown. He called it first. He called it best. And he has done the most thinking on the subject. What is he saying now about home prices and bank solvency?
If you want to know all there is to know about it, you might buy a copy of his new book – More Mortgage Meltdown. I've only scanned through the book (which he gave me at lunch), but it looks like a great read – a solid primer on how to be a thorough bottom-up investor.
Or... you could take the lazy man's route to knowledge and just look at what Whitney owns now in his portfolio. Answer? Wells Fargo and American Express. Thus, you'd know the worst is probably over in the mortgage business. I asked Whitney why he thought so. Here's a paraphrase of what he told me...
|
There's one thing, though, I think Whitney is missing: Where are the big bank revenues coming from? What's happening is plain to see, if anyone cares enough to look... The Fed is manipulating interest rates in a way that's designed to repair bank balance sheets. Short-term interest rates (from which banks fund their operations) are nearly zero. One-year T-bills are only yielding 0.35%. Meanwhile, 30-year fixed mortgage rates are around 5% – resulting in a "mortgage spread" of nearly 4.5%. That's the perfect recipe for banking profits.
The Fed is even buying lots of mortgages and Treasury bonds to make sure long-term interest rates won't move up and discourage anyone from buying a house. In short, it's the ideal environment for both the housing market and for banking. The government's idea for fixing the credit bubble of 1996-2006 seems to be simply manufacturing a new one.
I don't think it will work. There's a fly in the government's ointment, and that fly is inflation. But Whitney didn't even consider the risk. Instead, he put up a chart showing the impact of interest rates on stock market multiples. What happens to the stock market during periods of low interest rates? Obviously, when interest rates are low – like they are right now – stocks normally do pretty well, because there's no better way to make money.
But then I asked him the key question:
|
Whitney said he'd never looked at the numbers, but he didn't think it mattered all that much, because "interest rates are interest rates." Yikes. Er... sorry, Whitney... but nominal rates don't matter much at all. What matters are real interest rates.
Nobody, for example, wants to buy a banana republic's bonds – even if it's paying 20% – when inflation in the country is running at 50% annually. Doing so will cost you 30% of your money in one year. And... the same thing is now happening in America.
Let me explain... There are lots of ways of measuring inflation. The worst way – looking merely at consumer prices (CPI) – is what the government does. The best way is by looking at the size of the Federal Reserve monetary base. This shows you how much money is being created out of thin air.
The monetary base has basically doubled over the last year. But if you throw in all of the various guarantees the Fed is responsible for, the real size of the balance sheet has grown by a factor of 10. (The Fed is now guaranteeing more than $11 trillion of debt.) Folks who believe inflation is only measured by the CPI are about to learn an expensive lesson.
How do I measure inflation? Simple – just watch the price of gold. Gold is the free market's money. The U.S. dollar is the world's reserve currency – the government's money. You can either participate in the government-led economy (by holding dollar-denominated assets) or you can keep your savings in the free market (by holding gold).
Normally, you get paid to participate in the government-led racket – because doing so is risky, governments always default eventually. Meanwhile, gold doesn't pay a cent. Nor does it ever default.
So I believe the best way to figure out the real rate of interest on U.S. dollars is simply by measuring the change in the price of gold compared to the interest paid on U.S. Treasury notes, bills, and bonds. For example, this year, the price of gold is up roughly 20%. Meanwhile, a 10-year T-bond is paying roughly 3.5%. By lending the U.S. government money for 10 years, you would have lost roughly 16.5% of the intrinsic value (the purchasing power) of your savings. Not a very good deal.
The key question for stock market investors these days is: What really happens to stock prices during a period of negative real interest rates? It isn't pretty, my friends. Stocks generally trade at earnings multiples under 10 during periods of negative real interest rates. That's the bad news. The good news, though, is some companies do particularly well during periods of inflation and negative real interest rates.
The trick, then, is knowing how to invest during periods like the kind we're in right now. I know someone who does: Warren Buffett.
In April of this year, I explained this same thesis – that inflation was coming and that to survive, we would have to move into segments of the market that perform well during periods of negative real interest rates. I told my readers to buy three stocks in particular – three companies that own irreplaceable assets in the United States and whose debts were denominated in U.S. dollars.
Burlington Northern was one of these three stocks. As you know, Buffett seems to agree with me. He offered $100 per share for the whole company. We paid $65. That's a 53% return in six months. But you know what... I'm sorry to see the deal happen. It's not because I don't like making a huge return so quickly. It's because I know Buffett is right: Burlington is a phenomenal asset to own. Over the next 10 years, the value of its debts will be wiped out by inflation (negative real interest rates), while the dollar value of its irreplaceable assets will soar.
Take a look at this chart. It shows the price of Burlington Northern as measured in gold. Both gold and shares of Burlington Northern are ways of protecting yourself against inflation. And when we bought the stock in April, Burlington had never been cheaper compared to gold.
What were the other two stocks I recommended in April – stocks perfectly designed to prosper during periods of high inflation and negative real interest rates? My subscribers know. And so should you. A year-long subscription to my newsletter costs less than one night out for two at a good restaurant. Or less than one bottle of good wine. My April issue alone is worth more. Just sign up already. "It's clear Mr. Roubini hasn't done his homework, yet again," Jim Rogers told Bloomberg. Nouriel Roubini (the NYU economics profess dubbed "Dr. Doom") claims bubbles are forming in gold and emerging-market stocks. To refute Roubini, Rogers said commodity and emerging-market stocks are still down from their historical highs by at least 50%...
|
Rogers still isn't buying any stocks, but he's considering buying more gold, which he believes will hit at least $2,000 an ounce (based on the inflation-adjusted high of just over $2,000 in 1980) once the bull market in the yellow metal ends. However, he says gold could go "much, much higher." And Rogers still believes we've hit the point of maximum pessimism with the U.S. dollar, and the beaten-down currency should rally.
Our own Jeff Clark agrees with Rogers' thesis on the dollar, and he's currently formulating a super low-risk trade to take advantage of the dollar's upswing. However, one of Jeff's most reliable market indicators says stocks are due for a plunge. He's waiting for the S&P to hit a certain point – tripping his indicator – then he's going short, and big...
Acting on Jeff's trade could easily double your money in one week. There's still time to sign up for the S&A Short Report before Jeff releases his newest trades. To learn more, click here.
Make sure to read Steve Sjuggerud's latest special report for True Wealth readers... He's discovered a perfectly legal, little-known way to eliminate Social Security taxes. According to a study by Wharton (one of the world's finest business schools), using this strategy could save you more than $100,000 over a 30-year period.
The report includes six other secrets that could all make and/or save you tens of thousands of dollars every year. Not everyone will qualify for this money, and there are certain requirements, but if only one of these scenarios applies to you, you could immediately see thousands extra in your bank account. To receive this special report, click here.
New highs: Burlington Northern Santa Fe (BNI), Visa (V), Sprott Resources (SCP.TO), Jinshan (JIN.TO).
In the mailbag... Believe it or not, still more BSX bashing. When will it end? What's your score card of my stock picks look like, dear subscribers? Have I gotten anything right yet? Send it here: feedback@stansberryresearch.com.
"BSX is getting killed! Why! Horrible call." – Paid-up subscriber MJ
Porter comment: Now, look, you can't blame me (or credit me) for a stock's performance after we've recommended you sell it. If you didn't see our detailed analysis of what went wrong and why we recommended selling the stock, see last month's Digests. We've taken a 12% loss on BSX. We have moved on.
Keep in mind, the other dozen or so stocks I've recommended over the last year are nearly all up – including gains of 67%, 46%, 25%, and 19% on my best ideas to protect yourself from inflation. That doesn't include the 43% gain we just took on Bronco Drilling, which was recommended in September. We're up 55% on a REIT fund, after I reversed my bearish position on REITs at the bottom. We've even made money on high-yield bonds (18%) and shorting government bonds (16%). And everyone who reads my newsletter had the opportunity to buy Buffett's new railroad for about two-thirds of the price he just paid!
Obviously, nobody gets every single thing right when it comes to picking stocks. And I certainly got it wrong on BSX. But it's strange to me that in the midst of one of the best years ever in my career as a stock picker, the only stock my readers actually bought was the only bad pick I've made. Come on, folks, help me out here...
"A couple of days ago Porter was taking Doc to task over having said that inflation has not started yet. I have to agree with Doc. At my level of existence things like gas and groceries are cheaper than they were. Until prices of the things I buy in my daily life go up I don't consider it inflation... " – Paid-up subscriber Dave
Porter comment: Like I told Doc... Good luck with those ideas. By the time the inflation that's happening right now hits the CPI or retail prices in general, it will be far too late to preserve the purchasing power of your savings.
"You are often too much about my boat, my house, my talent, etc for my liking, but sometimes you do come up with something commendable and brave. My hat's off to you about the way you held your nerve and talked about the race thing. Whether you're a racist or not I wouldn't know, but to suggest your piece about Detroit makes you one is ridiculous. But the reaction certainly was predictable... " – Paid-up subscriber Eben van der Westhuizen
Porter comment: Keep your eyes on Atlanta's mayoral elections. There's a run-off between a fiscally conservative, Democratic woman (Mary Norwood) and a liberal black Democratic man (Kasim Reed). Reed has the support of the traditional black voting bloc and has campaigned explicitly on race. Mary Norwood has been campaigning with a promise of better, smaller, and cheaper government. In a city that's 60% black, Norwood captured 45% of the vote. Can she win in a run-off against a black opponent? If so, it would signal a new era of politics in Atlanta and the end of the black political machine.
"I live in a town within an hour of the Canadian border and recently traveled there to open a bank account which I was told must be done in person if a US citizen. Upon re-entering the States I was given the third degree by a US Customs officer about my business activities resulting in a brief detention complete with a detailed vehicle search, minor further questioning and TSA background check. These people were all business... jackbooted and armed. Being that I was clean and lawful I was back on my way quickly. All this for just opening a foreign bank account with verifiable funds via a bank draft. The writing is on the wall. You have advised me well Porter... thank you!" – Anonymous
Porter comment: Just wait. By the time OBAMA! leaves office, you won't be allowed to have a foreign bank account, you won't be allowed to take gold out of the country, and you won't be allowed to exchange dollars for foreign currencies, except on a small scale as required for travel.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
November 4, 2009