Report Card 2008

Report Card 2008
By Porter Stansberry

I've always had a feeling that some subscribers consider a newsletter's track record to be its main – even its only – measure of value.

Likewise, it has been my observation – after 13 years in the financial newsletter business – most publishers will resort to any and all kinds of subterfuge, fraud, or misdirection to avoid producing an honest and complete track record. There are all kinds of ways to make a bad track record look good. But most publishers take the simple path, the one of least resistance: They just never publish any track record at all.

That leaves subscribers to search out the results for themselves. Often, they turn to third-party sources that claim to offer research on newsletter track records. But in my experience, these sources are the most inaccurate of all. They'll do things like count any stock rated as a "hold" as being sold, which tends to severely discount the results of any letter that follows a long-term strategy. Worse, most of these "track-record keepers" offer no advice about the level of risk being taken by the newsletters. They'll promote a letter with a particularly hot recent track record – no matter how that record was achieved. So you wind up with letters enjoying high ratings – despite being written by alcoholics whose brains are so addled they can barely function, but whose track records seem amazing simply because they happened to recommend penny gold stocks during the huge bull market in gold. Within a year, you can have letters like this going from the highest-rated track record in the newsletter universe to the lowest. And that's not very helpful to any consumer looking for high-quality investment research.

High-quality investment research is what we've offered our clients since I launched this business in 1999. I won't publish anything I don't consider to be good advice. I have a simple, two-part test. First, would I want my own mother reading this newsletter and following its advice? And second, can I personally stand behind the advice we're offering and the claims we're making? Do I really believe our analyst has done a good job? Do I trust that his facts are well-researched and his conclusions are reasonable?

You might notice: I don't include any specific track-record result in my test of quality. I know that good investment ideas often take a long time to work out. And I know even the best-researched and soundest strategies sometimes result in a loss. The only investor who can always produce a positive return in any market environment is Bernard Madoff.

That's one reason I trust my own experience and my gut far more than I trust any purely objective track record. However, I still take the time each year to measure quantitatively how our analysts have performed. Only rarely will my estimate of their quality and the numeric results vary. And never for very long.

There have been times in the past (and there will undoubtedly be times in the future) when one of our products (or one of our analysts) can't pass these tests. If you've ever run a business, you understand sometimes quality slips. Sometimes people lose their desire to do excellent work. When that happens, we're quick to make changes. Likewise, we don't hesitate to create new products to take advantage of emerging opportunities in the markets. If a new strategy is working, we want to supply research about it.

I'm happy to tell you our little publishing company has done well over the years by sticking to these policies. Apparently, treating your customers with the same respect, dedication, and honesty you'd expect were the roles reversed is a rare commodity in finance. We wonder why more financial publishers haven't copied us by insisting on good investment performance in their products. We wonder how they expect to get the best out of their analysts if they don't insist on it, or even bother to measure it.

How to Measure Results?

There are many, many ways to measure newsletter track records. I constantly get e-mails from people claiming I've done it all wrong... I haven't supplied enough data (or I've published too much to wade through it all). Whatever I decide is likely to be the wrong way to a certain number of critics – all of whom seem to get louder and angrier every year.

My solution is simple: I give you the data. I give it to you every year. If you want to parse the numbers at leisure, go right ahead. You can put them in your Excel spreadsheet and make them dance any way you'd like. If you'd like even more data to consider, you can add the Report Cards from past years to your database. Further, since we archive all the back issues of our current products on our website, you can go back month by month if it pleases you to do so and calculate any number of time-factor delays and compounded results. Knock yourself out. Really. Have a good time. But please, don't bother sending me any angry e-mails about how I'm hiding our poor results or obfuscating the "truth" about our letters. That's nonsense: I've given you access to all the data. You can calculate it any way you'd like.

As for me, as I mentioned earlier, I prefer to judge the quality of our letters by qualitative measures – not solely by quantitative measures. And I'll share my thoughts in this regard as we review the Report Card.

To keep things simple, honest, and useful, I asked my analysts to send me a spreadsheet of all the recommendations they made during 2008 and the results based either on the closing price at the end of the year or on the price achieved by selling the investment (if such a sale occurred before the end of 2008).

Now, I can already hear the cacophony of critics: What about stocks recommended before 2008? They aren't included in this Report Card, which doesn't claim to be anything more than a sample of our editors' results. Why don't we include older recommendations? Because most of the time, the older recommendations aren't nearly as attractive as the newer ones. We want to judge our analysts on their best, current advice. Also, older investments frequently include large amounts of income accrued earlier in the holding period. It doesn't make sense to count a dividend paid in 2003 as part of your investment return in 2008.

The Report Card simply shows you how our analysts did on average during the past year. This tells you something about the quality of their work. You can learn more by looking at past Report Cards, studying the back issues (which are available for free to subscribers), and carefully considering the analyst's strategy and diligence.

That's really the best we can do. We are a researc
h and publishing company, not a mutual fund or a hedge fund. We don't have precise measures of our total returns, only average results of our recommendations made over given periods of time. And like I said earlier, if that's not good enough for you, you're welcome to the data. They're available on our website... free to subscribers.

So? How did we do?

Well, you might disagree with me, but I think we've done spectacularly well. On an overall basis, I would award our group an A for 2008. Could we have done better? Certainly. But I don't think any other investment group or research house got as many of the big things right in 2008 as we did.

You can go down the line of the biggest financial stories of the year – the collapse of the investment banks, the bankruptcy of GM, the debacle at Fannie and Freddie, the destruction in the commodity markets (especially oil), the fall of the euro, the strength of gold, the huge decline in stocks, etc. We predicted all these things in detail months and months before they occurred. Our official track record doesn't include these things. But there's no doubt our readers were far better off having read our warnings. Here's a small sample of them:

On the Stock Market Collapse:

I think we're close to an important top in equity prices. I can't tell you how close – and it could be months and months from now. Bullish sentiment is now pervasive. Stocks are rallying almost every day. Everything I follow has gotten too expensive to buy safely. And investors have begun to completely ignore risk... What we've seen in the market since the last bear run (2001-2002) is that almost everything has gone up. Value stocks, foreign stocks, commodity stocks, blue chips, hedge funds, insurance stocks, private-equity firms, technology, etc. Normally, you can find a sector that's been beat up for a few years. Not right now. This bull market has been the broadest four-year rally I've ever seen. Lots of investors think they're geniuses – especially the commodity guys... And since I can't tell you with any certainty on what day of the week this market will begin to decline, what use is it to tell you about the warning signs I see? I'm telling you because, were our roles reversed, I would expect you to tell me about these very troubling and bearish indicators. It's important to know that we might be entering a period of poor stock returns... For long-term investors, I think it makes sense to buy a little insurance. You can do this by buying a put option on a broad index of stocks. If you invest 3% to 5% of your portfolio in such an option, you can effectively hedge your portfolio against any general market decline. – Porter Stansberry, PSIA, February 2007

On the Destruction of the Credit Markets:

Private-equity powerhouse Blackstone Group is set to go public the week of June 25... Why would a successful business like Blackstone look to sell?... Our thoughts: Chief Executive Stephen Schwarzman and his partner Peter Peterson started this company in 1985 with $400,000. They've worked hard for 22 years. And they're no dummies. They've seen a top in the credit markets before... and this time they're cashing out. – Porter Stansberry, The S&A Digest, June 13, 2007

On the Oil and Gas Bubble:

The number of rigs drilling for natural gas increased to 1,473 for the week ending February 9, according to Baker Hughes. This is the highest gas-directed rig count for any week since record keeping by fuel type began in 1987... The number of natural gas rigs is about 11 percent greater than last year at this time, and about 69% higher than the 5-year average for this week... Although prices are much lower in recent months, the number of natural gas rigs has continued their upward trend... A record number of rigs will lead to a record amount of new supply. That will create a record amount of gas in storage. All these trends should converge around the end of this year... which will be just in time for a huge new source of natural gas capacity to come online: Cheniere's new LNG port. All four of the other LNG ports built in the U.S. went bankrupt within months of opening. Cheniere (AMEX: LNG) will be no exception. – Porter Stansberry, The S&A Digest, February 21, 2007

The Demise of Goldman Sachs & Its Phony Accounting:

Over the last three years, Goldman Sachs reported net income totaling $19.6 billion. On the basis of these "profits," the managers took their bonuses and their glory as Wall Street's smartest investment bank. Meanwhile, Goldman produced no net cash flow. In fact, cash flow over the last three years is negative $93.6 billion. There's a $113.2 billion disparity between the amount of cash the company produced from operations and the amount of profits it claimed via its accounting. Even when you factor in all of the returns from its investments (which produce negative operation cash flow), you still end up with a net negative number... –$800 million. I've got no doubt that Goldman has the world's smartest accountants. In fact, I wonder how many of them used to work at Enron... We can't say when Goldman will come clean, but we do know how: painfully. – Porter Stansberry, The S&A Digest, November 13, 2007

On the Collapse of Chinese Stocks:

There's nothing like a stock market mania in China. I covered the handover of Hong Kong in 1997. The return of Chinese rule ended decades of fear and uncertainty, sending Hong Kong stocks straight up for the first six months of 1997. Housewives
lined up around the block outside of brokerage firms, eager to pay any price for shares of so-called "red chip" stocks. These were stocks whose connections to mainland China supposedly assured them financial success. The whole charade blew up spectacularly, about two weeks after the handover was complete.

This year, the drama is repeating itself, except the focus of the mania this time is in Shanghai. Chinese mainland investors have lost their minds, bidding up the local shares of stocks, like PetroChina, to absurd prices. Based on its Shanghai-listed shares, PetroChina is now worth more than $1 trillion – roughly three times more than the exact same shares are worth in Hong Kong or New York. Baoshan Iron & Steel, China's premier steel company, has a local share value of $42 billion, more than three times that of U.S. Steel, though they have similar production volumes. Warren Buffett has cashed out of his entire PetroChina position. Which side of the trade do you want to be on? The Chinese housewife's or Warren Buffett's? – Porter Stansberry, The S&A Digest, November 5, 2007

On the Credit-Card Bust:

I now believe our country's mortgage crisis will spill over into the general economy because the fallout has already spread from development companies to mortgage banks to investment banks and now to credit-card companies. Capital One, the largest independent credit-card issuer in the U.S., recently announced it would take a $5.9 billion charge for bad debts in 2007. That's up from $3.1 billion in 2006 – a 90% increase in only one year.

Currently, the charge-off rate is only about 5% of Capital One's loan book. Watching Countrywide Financial, you'd have to assume the rate of bad credit-card debt will continue to grow higher. If 7% of people in America aren't paying their mortgages, I figure at least that many people aren't going to pay off their credit cards either.

As you can see, the system's leverage is magnifying the impact of falling real estate prices. And even worse, the damage to the banking system means it will be much more difficult for the Federal Reserve to stimulate economic growth through additional lending.

This is a time to be extremely cautious with your own finances. I believe the S&P 500 will fall this year, by more than 10%. Most stocks will probably decline this year. Thus, simply holding cash and gold isn't a bad strategy right now – your cash will probably outperform your stocks in 2008. – Porter Stansberry, DailyWealth, January 19, 2008

On the Bear Market in Stocks:

In 1981 – after 15 years of stagnant stock prices – cash represented 77.1% of all mutual fund assets.

In 1999, when stock market optimism was at its strongest, cash represented only 23.7% of all mutual fund assets.

Today, investors hold about the same percentage of cash as they did in 1999. As of October 2007, cash represents 24% of all mutual fund assets...

Right now, according to Investment Company Institute, the public is close to the lowest cash balance it has ever had relative to other investments. The ICI keeps detailed statistics on the assets the mutual fund industry controls. You can look up these statistics at http://www.ici.org/.

But you don't need statistics to figure this out... just look around you. Do you see your neighbors saving money, or did they just buy a new Hummer, condo, or vacation? Would they be more likely to buy a house or open up a new savings account?

Nope, no one wants to hold onto cash.

I love hated investments. This is one reason I like cash. It's such a contrarian investment.

But I have a more specific reason for liking cash. It's Jason Goepfert's "mutual fund cash indicator." When this indicator flashes a signal, the stock market declines 4% a year on average versus cash. The cash investment I'm going to recommend to you in a minute pays a 4.5% interest yield...

My favorite investment in cash is the Lehman 1-3 year bond fund ETF (SHY). SHY is the safest investment vehicle on the planet after gold. It's a fund of short-term bonds issued by the United States government. Short-term United States Treasury bonds are the most liquid assets on the planet. They are as good as cash. SHY pays a 4.5% dividend...

I expect it will beat stock market returns by 8.5% a year until mutual fund cash balances return back to normal levels. – Tom Dyson, DailyWealth, December 17, 2007

On the Mortgage Crisis:

The most urgent, important things I have to tell you are summed up by the following list: The financial crisis isn't half over yet, and you need to know just how big it really is. Housing prices have a long way to fall. Stay away from leveraged companies, banks, homebuilders, and the like. When you buy stocks, pick only the best names with the best managements and the least leverage. And only buy at a substantial discount to a value about which you're highly certain. – Dan Ferris, Extreme Value, April 2008

On the Global Economic Crisis:

As goes the global economy, so goes the share price of Cummins. Problem is, Cummins isn't "going" right now. After soaring hundreds of percent from '03 to '07, the stock has been hammered with a 30% loss in the past few weeks. Chart watchers would call this one a "breakdown"... from an economic standpoint, Cummins' chart is one of the biggest red flags in the market right now. – Brian Hunt, DailyWealth, January 18, 2008

On the Exchange Bubble:

Speaking of good shorts... We've never understood the popularity of the exchange stocks, like the Chicago Mercantile Exchange. It always seemed to us that businesses that could operate very well for decades as not-for-profit organizations wouldn't do very well in a for-profit structure. And... what do you know... as soon as these exchanges began trying to raise their prices to justify their soaring stock prices, their clients openly rebelled. – Porter Stansberry, The S&A Digest, February 15, 2008

On the Euro:

The euro has reached the point of ridiculousness. Here's a concrete example: A McDonald's Big Mac in Europe will cost you 50% more than a Big Mac in the States... According to the Economist, early 1995 was the last time a Big Mac was 50% more expensive in Europe than it was in the States. The last time Europe's currency got this expensive, it crashed by nearly half... We are at the brink of a major downtrend in the euro. I think it's time to make a safe wager. Bet against the euro while it's extremely overvalued and get out in two years or so. – Steve Sjuggerud, DailyWealth, August 5, 2008

There are many more examples of individual recommendations that have done well. (And lots of examples of individual recommendations that have done poorly, too.) I selected the examples above to demonstrate that we got so many of the big trends right. To me, that's the most important thing we offer: an objective (and correct) analysis of the big picture.

Now... how did we do with our specific recommendations?

The Grades

Let's start with Dan Ferris, who writes Extreme Value. Dan runs primarily a long-only portfolio of deep value stocks. I would have expected Dan to produce a negative average return in 2008. The S&P 500 was down 37%. The Nasdaq fell 40%. And even the broadest measures of stocks – like the Wilshire 4500 – were down by about the same amount (-40%). Most of the world's best value managers saw their portfolios fall sharply. Even value managers who can short stocks, like Whitney Tilson, were down during 2008 (-18.5%).

Dan Ferris picked 10 stocks during 2008. Half of them were up on the year. Half were down. Overall, his average pick was up 1.69%. That's outstanding. In fact, Dan did something nearly impossible: He picked a winning financial stock. His February recommendation of insurer W.R. Berkley ended the year up – one of the few financial stocks to do well in 2008. Dan also picked one short sell during 2008 – Lehman Brothers, which was the only large investment bank the government allowed to go bankrupt. I think you have to give Dan an A+ for 2008 – a truly remarkable performance.

I've also got to give Jeff Clark an A+. Jeff's trading this year in The S&A Short Report was nothing short of heroic. He made 52 recommendations – all of them short-term trades. Out of these, 42 made money. A win rate of more than 80% in options trading is ridiculous. The average return of every trade was a bit more than 31%. That's outrageous when you understand the short duration of these trades and the turnover in the portfolio. How outrageous? The cumulative total return was greater than 1,700%. And yes, our legal department has reviewed this track record – it's real.

In regards to Jeff's other newsletter, Advanced Income, the results were not great. Advanced Income is a long-only strategy. Jeff recommends stocks to sell calls against, to generate safe income. The 18 recommendations here produced an average loss of 1%. Nobody wants to lose money, but considering the devastation in the stock markets during 2008, a negative 1% return isn't bad.

Next, Brian Heyliger writes our insiders report Inside Strategist. Frankly, the strategy didn't work very well in 2007 and 2008 because insiders at financial firms kept buying shares – and kept getting wiped out. Remember: No strategy works all the time, unless you're Bernie Madoff. Heyliger did a good job of cutting his losses and concentrating on cheap stocks. He also did a good job of trading out of winning positions to bank his profits. Out of 28 recommendations, most (53%) were winners. The average return was 2.9% – which is a very good result in a terrible year for stocks. I'm going to give Brian an A: He survived an awful year for his strategy.

What about me? How did the boss do? Not well. I'm going to give myself a "gentleman's C" this year because, although I did identify the problems in the banking sector early, I didn't sell short enough of the stocks. That was my No. 1 mistake in 2008 – I wasn't aggressive enough when it came to shorting financial stocks, which I knew would collapse. That's the main lesson I'll remember from the year. Stick to the fundamentals. Don't let the fear of intervention stop you from making the trades you know are right.

Finally, as the crisis intensified, we did actively short the financial system – the very heart of it – via Fannie and Freddie. But if we'd stuck with the bad-debt theme throughout 2008 and shorted those financial institutions earlier, we would have made a killing instead of basically breaking even on the year.

Given the total carnage in the stock market, it's significant my buy recommendations in 2008 produced an average loss of only 13%. Believe me, I understand you don't subscribe to my newsletter to lose money. I know you can't "eat" comparative returns. The point I'm trying to make is, we wouldn't have done nearly as well as we did without limiting the losses we took on the long side. Our average return for 2008 was a loss of less than 1.5% – essentially breakeven. We accomplished this by doing three things most investors probably didn't do: 1) We hedged five out of our 13 long recommendations by selling covered calls. 2) We rigorously cut our losses, even when we were down on good stocks in which I have tremendous confidence – Starbucks, Texas Instruments, eBay, Take-Two. 3) We successfully shorted stocks throughout the year.

We'll continue our review and the Report Card on Monday.

Regards,

Porter Stansberry
Baltimore, Maryland
January 30, 2009

P.S. Don't forget tonight is the last night to qualify for the discount we're offering on Jeff's S&A Short Report. Click here to learn more.

Report Card 2008
By Porter Stansberry

I've always had a feeling that some subscribers consider a newsletter's track record to be its main – even its only – measure of value.

Likewise, it has been my observation – after 13 years in the financial newsletter business – most publishers will resort to any and all kinds of subterfuge, fraud, or misdirection to avoid producing an honest and complete track record. There are all kinds of ways to make a bad track record look good. But most publishers take the simple path, the one of least resistance: They just never publish any track record at all.

That leaves subscribers to search out the results for themselves. Often, they turn to third-party sources that claim to offer research on newsletter track records. But in my experience, these sources are the most inaccurate of all. They'll do things like count any stock rated as a "hold" as being sold, which tends to severely discount the results of any letter that follows a long-term strategy. Worse, most of these "track-record keepers" offer no advice about the level of risk being taken by the newsletters. They'll promote a letter with a particularly hot recent track record – no matter how that record was achieved. So you wind up with letters enjoying high ratings – despite being written by alcoholics whose brains are so addled they can barely function, but whose track records seem amazing simply because they happened to recommend penny gold stocks during the huge bull market in gold. Within a year, you can have letters like this going from the highest-rated track record in the newsletter universe to the lowest. And that's not very helpful to any consumer looking for high-quality investment research.

High-quality investment research is what we've offered our clients since I launched this business in 1999. I won't publish anything I don't consider to be good advice. I have a simple, two-part test. First, would I want my own mother reading this newsletter and following its advice? And second, can I personally stand behind the advice we're offering and the claims we're making? Do I really believe our analyst has done a good job? Do I trust that his facts are well-researched and his conclusions are reasonable?

You might notice: I don't include any specific track-record result in my test of quality. I know that good investment ideas often take a long time to work out. And I know even the best-researched and soundest strategies sometimes result in a loss. The only investor who can always produce a positive return in any market environment is Bernard Madoff.

That's one reason I trust my own experience and my gut far more than I trust any purely objective track record. However, I still take the time each year to measure quantitatively how our analysts have performed. Only rarely will my estimate of their quality and the numeric results vary. And never for very long.

There have been times in the past (and there will undoubtedly be times in the future) when one of our products (or one of our analysts) can't pass these tests. If you've ever run a business, you understand sometimes quality slips. Sometimes people lose their desire to do excellent work. When that happens, we're quick to make changes. Likewise, we don't hesitate to create new products to take advantage of emerging opportunities in the markets. If a new strategy is working, we want to supply research about it.

I'm happy to tell you our little publishing company has done well over the years by sticking to these policies. Apparently, treating your customers with the same respect, dedication, and honesty you'd expect were the roles reversed is a rare commodity in finance. We wonder why more financial publishers haven't copied us by insisting on good investment performance in their products. We wonder how they expect to get the best out of their analysts if they don't insist on it, or even bother to measure it.

How to Measure Results?

There are many, many ways to measure newsletter track records. I constantly get e-mails from people claiming I've done it all wrong... I haven't supplied enough data (or I've published too much to wade through it all). Whatever I decide is likely to be the wrong way to a certain number of critics – all of whom seem to get louder and angrier every year.

My solution is simple: I give you the data. I give it to you every year. If you want to parse the numbers at leisure, go right ahead. You can put them in your Excel spreadsheet and make them dance any way you'd like. If you'd like even more data to consider, you can add the Report Cards from past years to your database. Further, since we archive all the back issues of our current products on our website, you can go back month by month if it pleases you to do so and calculate any number of time-factor delays and compounded results. Knock yourself out. Really. Have a good time. But please, don't bother sending me any angry e-mails about how I'm hiding our poor results or obfuscating the "truth" about our letters. That's nonsense: I've given you access to all the data. You can calculate it any way you'd like.

As for me, as I mentioned earlier, I prefer to judge the quality of our letters by qualitative measures – not solely by quantitative measures. And I'll share my thoughts in this regard as we review the Report Card.

To keep things simple, honest, and useful, I asked my analysts to send me a spreadsheet of all the recommendations they made during 2008 and the results based either on the closing price at the end of the year or on the price achieved by selling the investment (if such a sale occurred before the end of 2008).

Now, I can already hear the cacophony of critics: What about stocks recommended before 2008? They aren't included in this Report Card, which doesn't claim to be anything more than a sample of our editors' results. Why don't we include older recommendations? Because most of the time, the older recommendations aren't nearly as attractive as the newer ones. We want to judge our analysts on their best, current advice. Also, older investments frequently include large amounts of income accrued earlier in the holding period. It doesn't make sense to count a dividend paid in 2003 as part of your investment return in 2008.

The Report Card simply shows you how our analysts did on average during the past year. This tells you something about the quality of their work. You can learn more by looking at past Report Cards, studying the back issues (which are available for free to subscribers), and carefully considering the analyst's strategy and diligence.

That's really the best we can do. We are a researc
h and publishing company, not a mutual fund or a hedge fund. We don't have precise measures of our total returns, only average results of our recommendations made over given periods of time. And like I said earlier, if that's not good enough for you, you're welcome to the data. They're available on our website... free to subscribers.

So? How did we do?

Well, you might disagree with me, but I think we've done spectacularly well. On an overall basis, I would award our group an A for 2008. Could we have done better? Certainly. But I don't think any other investment group or research house got as many of the big things right in 2008 as we did.

You can go down the line of the biggest financial stories of the year – the collapse of the investment banks, the bankruptcy of GM, the debacle at Fannie and Freddie, the destruction in the commodity markets (especially oil), the fall of the euro, the strength of gold, the huge decline in stocks, etc. We predicted all these things in detail months and months before they occurred. Our official track record doesn't include these things. But there's no doubt our readers were far better off having read our warnings. Here's a small sample of them:

On the Stock Market Collapse:

I think we're close to an important top in equity prices. I can't tell you how close – and it could be months and months from now. Bullish sentiment is now pervasive. Stocks are rallying almost every day. Everything I follow has gotten too expensive to buy safely. And investors have begun to completely ignore risk... What we've seen in the market since the last bear run (2001-2002) is that almost everything has gone up. Value stocks, foreign stocks, commodity stocks, blue chips, hedge funds, insurance stocks, private-equity firms, technology, etc. Normally, you can find a sector that's been beat up for a few years. Not right now. This bull market has been the broadest four-year rally I've ever seen. Lots of investors think they're geniuses – especially the commodity guys... And since I can't tell you with any certainty on what day of the week this market will begin to decline, what use is it to tell you about the warning signs I see? I'm telling you because, were our roles reversed, I would expect you to tell me about these very troubling and bearish indicators. It's important to know that we might be entering a period of poor stock returns... For long-term investors, I think it makes sense to buy a little insurance. You can do this by buying a put option on a broad index of stocks. If you invest 3% to 5% of your portfolio in such an option, you can effectively hedge your portfolio against any general market decline. – Porter Stansberry, PSIA, February 2007

On the Destruction of the Credit Markets:

Private-equity powerhouse Blackstone Group is set to go public the week of June 25... Why would a successful business like Blackstone look to sell?... Our thoughts: Chief Executive Stephen Schwarzman and his partner Peter Peterson started this company in 1985 with $400,000. They've worked hard for 22 years. And they're no dummies. They've seen a top in the credit markets before... and this time they're cashing out. – Porter Stansberry, The S&A Digest, June 13, 2007

On the Oil and Gas Bubble:

The number of rigs drilling for natural gas increased to 1,473 for the week ending February 9, according to Baker Hughes. This is the highest gas-directed rig count for any week since record keeping by fuel type began in 1987... The number of natural gas rigs is about 11 percent greater than last year at this time, and about 69% higher than the 5-year average for this week... Although prices are much lower in recent months, the number of natural gas rigs has continued their upward trend... A record number of rigs will lead to a record amount of new supply. That will create a record amount of gas in storage. All these trends should converge around the end of this year... which will be just in time for a huge new source of natural gas capacity to come online: Cheniere's new LNG port. All four of the other LNG ports built in the U.S. went bankrupt within months of opening. Cheniere (AMEX: LNG) will be no exception. – Porter Stansberry, The S&A Digest, February 21, 2007

The Demise of Goldman Sachs & Its Phony Accounting:

Over the last three years, Goldman Sachs reported net income totaling $19.6 billion. On the basis of these "profits," the managers took their bonuses and their glory as Wall Street's smartest investment bank. Meanwhile, Goldman produced no net cash flow. In fact, cash flow over the last three years is negative $93.6 billion. There's a $113.2 billion disparity between the amount of cash the company produced from operations and the amount of profits it claimed via its accounting. Even when you factor in all of the returns from its investments (which produce negative operation cash flow), you still end up with a net negative number... –$800 million. I've got no doubt that Goldman has the world's smartest accountants. In fact, I wonder how many of them used to work at Enron... We can't say when Goldman will come clean, but we do know how: painfully. – Porter Stansberry, The S&A Digest, November 13, 2007

On the Collapse of Chinese Stocks:

There's nothing like a stock market mania in China. I covered the handover of Hong Kong in 1997. The return of Chinese rule ended decades of fear and uncertainty, sending Hong Kong stocks straight up for the first six months of 1997. Housewives
lined up around the block outside of brokerage firms, eager to pay any price for shares of so-called "red chip" stocks. These were stocks whose connections to mainland China supposedly assured them financial success. The whole charade blew up spectacularly, about two weeks after the handover was complete.

This year, the drama is repeating itself, except the focus of the mania this time is in Shanghai. Chinese mainland investors have lost their minds, bidding up the local shares of stocks, like PetroChina, to absurd prices. Based on its Shanghai-listed shares, PetroChina is now worth more than $1 trillion – roughly three times more than the exact same shares are worth in Hong Kong or New York. Baoshan Iron & Steel, China's premier steel company, has a local share value of $42 billion, more than three times that of U.S. Steel, though they have similar production volumes. Warren Buffett has cashed out of his entire PetroChina position. Which side of the trade do you want to be on? The Chinese housewife's or Warren Buffett's? – Porter Stansberry, The S&A Digest, November 5, 2007

On the Credit-Card Bust:

I now believe our country's mortgage crisis will spill over into the general economy because the fallout has already spread from development companies to mortgage banks to investment banks and now to credit-card companies. Capital One, the largest independent credit-card issuer in the U.S., recently announced it would take a $5.9 billion charge for bad debts in 2007. That's up from $3.1 billion in 2006 – a 90% increase in only one year.

Currently, the charge-off rate is only about 5% of Capital One's loan book. Watching Countrywide Financial, you'd have to assume the rate of bad credit-card debt will continue to grow higher. If 7% of people in America aren't paying their mortgages, I figure at least that many people aren't going to pay off their credit cards either.

As you can see, the system's leverage is magnifying the impact of falling real estate prices. And even worse, the damage to the banking system means it will be much more difficult for the Federal Reserve to stimulate economic growth through additional lending.

This is a time to be extremely cautious with your own finances. I believe the S&P 500 will fall this year, by more than 10%. Most stocks will probably decline this year. Thus, simply holding cash and gold isn't a bad strategy right now – your cash will probably outperform your stocks in 2008. – Porter Stansberry, DailyWealth, January 19, 2008

On the Bear Market in Stocks:

In 1981 – after 15 years of stagnant stock prices – cash represented 77.1% of all mutual fund assets.

In 1999, when stock market optimism was at its strongest, cash represented only 23.7% of all mutual fund assets.

Today, investors hold about the same percentage of cash as they did in 1999. As of October 2007, cash represents 24% of all mutual fund assets...

Right now, according to Investment Company Institute, the public is close to the lowest cash balance it has ever had relative to other investments. The ICI keeps detailed statistics on the assets the mutual fund industry controls. You can look up these statistics at http://www.ici.org/.

But you don't need statistics to figure this out... just look around you. Do you see your neighbors saving money, or did they just buy a new Hummer, condo, or vacation? Would they be more likely to buy a house or open up a new savings account?

Nope, no one wants to hold onto cash.

I love hated investments. This is one reason I like cash. It's such a contrarian investment.

But I have a more specific reason for liking cash. It's Jason Goepfert's "mutual fund cash indicator." When this indicator flashes a signal, the stock market declines 4% a year on average versus cash. The cash investment I'm going to recommend to you in a minute pays a 4.5% interest yield...

My favorite investment in cash is the Lehman 1-3 year bond fund ETF (SHY). SHY is the safest investment vehicle on the planet after gold. It's a fund of short-term bonds issued by the United States government. Short-term United States Treasury bonds are the most liquid assets on the planet. They are as good as cash. SHY pays a 4.5% dividend...

I expect it will beat stock market returns by 8.5% a year until mutual fund cash balances return back to normal levels. – Tom Dyson, DailyWealth, December 17, 2007

On the Mortgage Crisis:

The most urgent, important things I have to tell you are summed up by the following list: The financial crisis isn't half over yet, and you need to know just how big it really is. Housing prices have a long way to fall. Stay away from leveraged companies, banks, homebuilders, and the like. When you buy stocks, pick only the best names with the best managements and the least leverage. And only buy at a substantial discount to a value about which you're highly certain. – Dan Ferris, Extreme Value, April 2008

On the Global Economic Crisis:

As goes the global economy, so goes the share price of Cummins. Problem is, Cummins isn't "going" right now. After soaring hundreds of percent from '03 to '07, the stock has been hammered with a 30% loss in the past few weeks. Chart watchers would call this one a "breakdown"... from an economic standpoint, Cummins' chart is one of the biggest red flags in the market right now. – Brian Hunt, DailyWealth, January 18, 2008

On the Exchange Bubble:

Speaking of good shorts... We've never understood the popularity of the exchange stocks, like the Chicago Mercantile Exchange. It always seemed to us that businesses that could operate very well for decades as not-for-profit organizations wouldn't do very well in a for-profit structure. And... what do you know... as soon as these exchanges began trying to raise their prices to justify their soaring stock prices, their clients openly rebelled. – Porter Stansberry, The S&A Digest, February 15, 2008

On the Euro:

The euro has reached the point of ridiculousness. Here's a concrete example: A McDonald's Big Mac in Europe will cost you 50% more than a Big Mac in the States... According to the Economist, early 1995 was the last time a Big Mac was 50% more expensive in Europe than it was in the States. The last time Europe's currency got this expensive, it crashed by nearly half... We are at the brink of a major downtrend in the euro. I think it's time to make a safe wager. Bet against the euro while it's extremely overvalued and get out in two years or so. – Steve Sjuggerud, DailyWealth, August 5, 2008

There are many more examples of individual recommendations that have done well. (And lots of examples of individual recommendations that have done poorly, too.) I selected the examples above to demonstrate that we got so many of the big trends right. To me, that's the most important thing we offer: an objective (and correct) analysis of the big picture.

Now... how did we do with our specific recommendations?

The Grades

Let's start with Dan Ferris, who writes Extreme Value. Dan runs primarily a long-only portfolio of deep value stocks. I would have expected Dan to produce a negative average return in 2008. The S&P 500 was down 37%. The Nasdaq fell 40%. And even the broadest measures of stocks – like the Wilshire 4500 – were down by about the same amount (-40%). Most of the world's best value managers saw their portfolios fall sharply. Even value managers who can short stocks, like Whitney Tilson, were down during 2008 (-18.5%).

Dan Ferris picked 10 stocks during 2008. Half of them were up on the year. Half were down. Overall, his average pick was up 1.69%. That's outstanding. In fact, Dan did something nearly impossible: He picked a winning financial stock. His February recommendation of insurer W.R. Berkley ended the year up – one of the few financial stocks to do well in 2008. Dan also picked one short sell during 2008 – Lehman Brothers, which was the only large investment bank the government allowed to go bankrupt. I think you have to give Dan an A+ for 2008 – a truly remarkable performance.

I've also got to give Jeff Clark an A+. Jeff's trading this year in The S&A Short Report was nothing short of heroic. He made 52 recommendations – all of them short-term trades. Out of these, 42 made money. A win rate of more than 80% in options trading is ridiculous. The average return of every trade was a bit more than 31%. That's outrageous when you understand the short duration of these trades and the turnover in the portfolio. How outrageous? The cumulative total return was greater than 1,700%. And yes, our legal department has reviewed this track record – it's real.

In regards to Jeff's other newsletter, Advanced Income, the results were not great. Advanced Income is a long-only strategy. Jeff recommends stocks to sell calls against, to generate safe income. The 18 recommendations here produced an average loss of 1%. Nobody wants to lose money, but considering the devastation in the stock markets during 2008, a negative 1% return isn't bad.

Next, Brian Heyliger writes our insiders report Inside Strategist. Frankly, the strategy didn't work very well in 2007 and 2008 because insiders at financial firms kept buying shares – and kept getting wiped out. Remember: No strategy works all the time, unless you're Bernie Madoff. Heyliger did a good job of cutting his losses and concentrating on cheap stocks. He also did a good job of trading out of winning positions to bank his profits. Out of 28 recommendations, most (53%) were winners. The average return was 2.9% – which is a very good result in a terrible year for stocks. I'm going to give Brian an A: He survived an awful year for his strategy.

What about me? How did the boss do? Not well. I'm going to give myself a "gentleman's C" this year because, although I did identify the problems in the banking sector early, I didn't sell short enough of the stocks. That was my No. 1 mistake in 2008 – I wasn't aggressive enough when it came to shorting financial stocks, which I knew would collapse. That's the main lesson I'll remember from the year. Stick to the fundamentals. Don't let the fear of intervention stop you from making the trades you know are right.

Finally, as the crisis intensified, we did actively short the financial system – the very heart of it – via Fannie and Freddie. But if we'd stuck with the bad-debt theme throughout 2008 and shorted those financial institutions earlier, we would have made a killing instead of basically breaking even on the year.

Given the total carnage in the stock market, it's significant my buy recommendations in 2008 produced an average loss of only 13%. Believe me, I understand you don't subscribe to my newsletter to lose money. I know you can't "eat" comparative returns. The point I'm trying to make is, we wouldn't have done nearly as well as we did without limiting the losses we took on the long side. Our average return for 2008 was a loss of less than 1.5% – essentially breakeven. We accomplished this by doing three things most investors probably didn't do: 1) We hedged five out of our 13 long recommendations by selling covered calls. 2) We rigorously cut our losses, even when we were down on good stocks in which I have tremendous confidence – Starbucks, Texas Instruments, eBay, Take-Two. 3) We successfully shorted stocks throughout the year.

We'll continue our review and the Report Card on Monday.

Regards,

Porter Stansberry
Baltimore, Maryland
January 30, 2009

P.S. Don't forget tonight is the last night to qualify for the discount we're offering on Jeff's S&A Short Report. Click here to learn more.