S&P 500 earnings are on pace to hit an all-time high of $91 a share by August. That's up nearly 13-fold from the March 2009 lows of $7 a share. And it would represent an all-time high… surpassing the prior record of $90 a share it reached in the third quarter of 2007.
The rise in profits is no real surprise… Fed Chair Ben Bernanke has flooded the market with trillions of dollars. The fresh capital and a 0% federal-funds rate caused corporate profits to soar.
The "velocity" of those earnings, however, is unusual. We've enjoyed the quickest recovery since at least 1900.
As Porter pointed out in last Friday's Digest, the biggest contributor to the bull market is the financial sector:
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The entire rise in U.S. corporate profits came from the financial sector. That is, the earnings growth driving our current bull market in stocks is coming exclusively from the financial sector. The nonfinancial sector of our economy actually saw profits fall in last year's fourth quarter. Today, financial sector profits make up more than 30% of total domestic corporate profits. That's the same level we saw in 2006 and 2007... just before the financial crisis. – Porter Stansberry, April 1, 2011, S&A Digest |
Corporate profits are also soaring despite near record-high unemployment. This makes sense, considering the source of the financial sector's profits. (It can generate higher profits by deploying more capital, which doesn't necessarily require more employees.) In the second quarter of 2007, corporate profits totaled $1.565 trillion annually, while the unemployment rate was 4.5%. By the third quarter of 2010, corporate profits increased to an annual rate of $1.64 trillion. But unemployment had more than doubled to 9.6%. How sustainable does this rally seem to you?
That's the problem with record earnings… or record anything for that matter... Eventually, they come back to Earth. A reversion to the mean – a return to average levels from an extreme – is only more certain considering the weak fundamentals of the current rally.
Jeremy Grantham, of value investing money manager GMO, is the market's No. 1 proponent of mean reversion. And he used this concept to time both the market top in 2007 and bottom in 2009. In his first quarter 2009 letter, Grantham wrote he was increasing his fund's allocation to equities. In fact, Grantham was bullish on nearly everything at that time... except for corporate profit margins. As predicted, equities soared. But profit margins followed suit. Grantham updated his bearish call on margins in his latest letter, from January 2011 (emphasis added):
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On one part of the fundamentals we were, in contrast, completely wrong. On the topic of potential problems, I wrote, "Not the least of these will be downward pressure on profit margins that for 20 years had benefited from rising asset prices sneaking through into margins." Why I was so wrong, I cannot say, because I still don't understand how the U.S. could have massive numbers of unused labor and industrial capacity yet still have peak profit margins. This has never happened before. In fact, before Greenspan, there was a powerful positive correlation between profit margins and capacity in the expected direction. It is one of the reasons that we in asset allocation strongly suspect the bedrock on which these fat profits rest. We still expect margins to regress to more normal levels. |
In the January 2011 letter, Grantham also discussed bubbles... and how to recognize them. First, he said every famous bubble burst after short-term rates started to rise. Considering short-term rates are close to zero, they have nowhere to go but up. He also noticed another interesting signal...
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The very famous, very large bubbles also often give another type of warning. Probably knowing they are dancing close to the cliff and yet reluctant to stop, late in bubbles investors often migrate to safer stocks, and risky stocks betray their high betas by underperforming. We can get into the details another time, but suffice it to say that there are usually warnings, sometimes several, before a bubble breaks. Overvaluation must be present to define a bubble, but it is not a useful warning in and of itself. |
People are getting comfortable with this rally... And retail investors could push this market higher as the last entrants. We should expect the rally in smaller-cap stocks to continue until at least June of this year, when the second round of quantitative easing (QE2) is supposed to end. When the government money stops flowing (which is far from a certainty), much of the speculative money will also stop. Using the Russell 2000 – an index of the 2,000 smallest securities based on market cap – versus the Dow, we can see small-cap stocks still rule…
Dan Ferris first recommended Alexander & Baldwin in the October 2002 issue of Extreme Value. He recommended the stock after visiting Hawaii to walk the company's land (and visiting the local tax assessor's office to research the value of that land). He liked the stock because its shipping arm controlled nearly all Hawaiian exports and imports. And its agricultural arm (which grows sugarcane), carried land on the books far below market value. It was a classic value play. He wrote:
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The current value of Alexander & Baldwin's entire company is easily between $2 to $5 billion. That's two to five times its current price. At its current stock price of around 8 times earnings, it is 50% cheaper as a going concern than the long term average price of stocks in general at 16 times earnings... Alexander & Baldwin creates value by entitling land. That process alone will create close to $20 billion in value over the next 10 – 15 years. Currently, over 11,000 acres are available for entitlement. |
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The potential value of this land is nearly 20 times what the entire company sells for today... Finally, if you want to know how safe this stock is to buy, remember to ask yourself just one question: Will Hawaiian real estate ever sell for anywhere near $150 an acre? The answer, of course, is no. That price is from another time, long gone now. That simple fact provides Alexander & Baldwin shareholders with the ultimate margin of safety. |
Last week, billionaire hedge-fund manager Bill Ackman announced a nearly 10% position in Alexander & Baldwin. Shares jumped more than 19% on the news. Extreme Value readers made more than 200% on the position. That's nearly 14% a year over the eight-and-a-half-year holding period (a particularly volatile eight and a half years).
In his latest Extreme Value, published today, Dan tells readers exactly how to position their portfolios to profit in today's market. He's also recommended shorting a company he says is manipulating earnings. If he's right, shares will surely plummet. To learn more about Extreme Value, click here...
You may recall a past Digest Porter wrote about "the best resource investor" he's ever met. (I'd recommend you read that entire Digest.):
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But unlike just about everyone else, Doug didn't sell. So he didn't realize the losses. Instead, he added to his positions. Today, he's undoubtedly many, many times richer because of his patience and knowledge. That's why, even though Doug sells a competing product, I heavily endorse his company's research. Let me say this more plainly, if you're planning to get rich in stocks (as opposed to merely getting richer) there's no better guide than Doug Casey. |
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As the End of America crisis plays out over the next few years, investors who are able to buy the world's best resources – during moments of panic – will earn massive fortunes. The big run between 2008 and now will be repeated... probably about every two or three years. Sooner or later, you'll have another "this is it" opportunity. The question is, will you know what to buy? Will you be familiar enough with the world's best resources to put your money in play while everyone else is frozen by panic? If you are, you'll make a fortune. |
If you've never read anything by Casey Research, now's your chance. It recently opened admission into its exclusive service, Casey's Investment Alert. This service isn't for everyone. First off, it deals in volatile small-cap mining stocks. While these stocks are the quickest way to get rich, they are also very risky. (Casey Research is one of the few firms we trust to recommend these stocks.)
Second, this service is expensive. To keep out the "noise," Casey Research charges a lot for its Investment Alert... This service contains its best small-cap mining recommendations. These stocks can only handle a limited number of investors, so Casey limits the number of subscribers. In fact, I believe this offer will only be open for a few more days. If you're interested in learning how to get rich in the junior mining space, please click here to learn more about the latest offer from Casey Research.
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New 52-highs (as of 4/1/11): First Trust Dow Jones Select MicroCap (FDM), Westport Innovations (WPRT), Coca-Cola (KO), Automatic Data Processing (ADP), WD-40 (WDFC), HMS Holdings (HMSY), Molina Healthcare (MOH), iShares Silver (SLV), Cenovus Energy (CVE), Dorchester Minerals (DMLP), SandRidge Energy (SD), Tetra Technologies (TTI), Tejon Ranch (TRC), SVB Financial (SIVB), Alexander & Baldwin (ALEX).
Lots of vitriol in today's mailbag. You'd think the nice weather over the weekend would have calmed everyone down. Send us your thoughts here... feedback@stansberryresearch.com.
"Your words: 'The question I pose to you, dear subscriber, is this: If this isn't socialism, what is? And when in the entire history of humanity has socialism ever created a sustainable bull market or any real prosperity?'
"Answer: You are obviously unfamiliar with the greatest socio-economic success story of our time: Norway. They have socialized medicine, a 'womb-to-tomb' coverage with high quality care, a government they trust, a tax structure they support, and the second highest income per capita in the world, just behind Saudi Arabia. And they have arguably the most civil society on earth.
"Only 3% of Norway is tillable, so they are not rich in terms of growing food. But when oil was discovered off the western coast over 40 years ago, they entrusted its development to their representative government, forming Statoil which is a government/private partnership company. The symbol is STO and it hit a 2-and-a-half year high today.
"Norway has no sovereign debt, it has huge sovereign assets which it invests globally with an eye to moral outcomes. The investments are publicly held and managed for the benefit of the entire population.
"The point is that the venom you laissez-faire analysts regularly vent based on what you consider immutable economic principles is misplaced because your argument is erroneous. It is indeed possible for a social democracy to exist and thrive when the population respects its representatives and its public employees and those people, in turn, respect the public.
"I am a 61-year-old retired Iowa farmer. But I have spent a year of my (mostly younger) life living – studying and working – in Norway, so I have felt the love. Norwegians understand and appreciate the value of the individual, while Americans understand the value of an 'asset.'
"You might be surprised what can happen when people devote themselves to the advancement of the whole, instead of concentrating on the narrow self-interest you seem to think is the only true element of economics.
"Look around... Don't be so cock-sure you know everything. We could all learn something from the Norwegian experience." – Paid-up subscriber Ralf Mosbo
Porter comment: Yes... When a few thousand highly homogeneous people discover a massive oil well in their frozen darkness, the appearance of wealth is created – temporarily. But what do you think will happen to Norway when the oil runs out?
"I recently sent my brother a copy of an interview with Porter Stansberry explaining how to protect yourself from the End of America, from a link in Mar. 31 S&A Digest. I'm new to S&A, and I like what I've seen so far. I know my brother is more liberal minded than me, but he surprised me with the venom in his reply: 'Have you done any research on Porter Stansberry? The guy is a scam artist and a fear monger. I despise this kind of dissemination of right wing propaganda that permeates the Internet which people believe but no one bothers to analyze or verify anything these crooks say.'
"I also sent him a copy of a message from Dr. Martin Weiss, from Money and Markets, 'New Protests, Riots and Revolutions: 5 Lessons for Investors." His reply was: 'There is nothing in this article I didn't already know. The world economy may get worse, it may not. I am not interested in a subsistence existence unless it is forced upon me. I prefer to participate in the political and economic life of this country and do my best to minimize the suffering.'"
"It seems when you talk about the End of America, some people get upset. Perhaps the element of truth to the conjecture triggers a raw nerve?
"I also read the S&A pdf article about divorcing oneself from the USA tax system by going expat. I meditated on this idea for some hours today, while riding my bike. I've decided that USA is not so bad if you stay financially poor. To live in poverty without becoming a welfare case, is an honorable way to live. Just learn to be happy with the things that are really free, like air and sunshine!" – Paid-up subscriber KB
Porter comment: I think it's interesting that people are happy to call me names (without having read my work). But they never offer any argument against the ideas I present.
Regards,
Sean Goldsmith and Porter Stansberry
Baltimore, Maryland
April 4, 2011
Record earnings for the S&P 500... Mean reversion... How to recognize bubbles... 200% for Extreme Value readers... The vitriol returns...