S&A Digest: The real lunacy begins

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As of 06/19/2013

The real lunacy begins... Grantham buys gold... Where I disagree with Mr. Ferris... The joys of investing in Russia... Eat the Rich II... Why you should try our Monthly Dividend Program...

"So far, Washington has put its political capital into trying to refinance salvageable homes for unsalvageable homeowners, when a relevant policy would consist of judiciously buying houses and demolishing them... Fannie and Freddie's strength is housing marketing software: They could be put to work devising a least-cost, maximum-bang strategy for demolishing unoccupied homes to preserve as much value as possible for the homeowners and mortgage creditors who remain..."

With these words, Holman W. Jenkins Jr. of the Wall Street Journal has officially launched the start of the lunacy phase of this crisis.

Don't laugh. His essay wasn't a joke (today's not April 1st). According to Jenkins, the way to solve the "problem" of falling home prices is to reduce the supply of housing. A record number of single-family homes, apartments, and condos sit empty. So, he argues, we should simply tear them down.

This same kind of nonsense created the Great Depression, when FDR mandated slaughtering entire herds of livestock to support commodity prices. Sadly, he's not the only voice advocating this stupidity. People who should know better, like Pimco's Bill Gross, are saying much the same thing: "Buy one million new/unoccupied homes, blow them up, and then start all over again."

Dear friends, let me remind you of the most basic principle of economics: You cannot become wealthy through the destruction of assets.

Perma-bear (and legendary investor) Jeremy Grantham told a crowd of investors he is "officially scared."

"In 2000," he said, "we had a technology bubble. But this is massive, a massive credit crisis and a bubble in global housing, global equity and global land." He called it the "first truly global bubble." When asked by a money manager what to buy now, he said "long mattresses" to store cash. He seriously suggested putting money into high-quality hedge funds. Also, Grantham admitted, "I bought my first gold last week, and I hate gold. It doesn't pay a dividend. I would only do it if I was desperate."

JPMorgan Chase is advising emerging-market investors to dump Russia and Brazil and buy China, as the economic slump reduces profits at energy companies and slows inflation in China.

We always take the forecasts of major investment banks with a large helping of salt. But in this case, we happen to agree with ol' JP. The emerging markets are crashing. This indicates commodity prices are due for a correction, and the U.S. economy is probably slowing a lot faster than anyone realizes.

JPMorgan cut Russian equities to "underweight" from "neutral" due to "unconventional" government policies... Last Thursday, Putin accused Igor Zyuzin, majority owner of steelmaker Mechel, of charging higher prices in Russia than the rest of the world. Then, Putin accused Mechel of tax evasion. Oh... the joys of investing in Russia...

Bond giant Pimco filed documents with regulators to launch its first bond ETF. The fund will track the Lehman Brothers Aggregate Index, a common benchmark for bond ETFs.

I've been friends with Dan Ferris for more than 10 years. I asked him to coauthor The Digest with me (on Tuesdays and Thursdays) because he's the best single stock analyst I've ever met... and because he approaches our work with a single-minded devotion that borders on madness. (For example: Not trusting the ability of computers to scan stock databases for attractive companies, Dan routinely reads thousands of annual reports each quarter.)

As much as I respect Dan's work ethic, his abilities, and his contrarian nature... we don't agree, at all, on a few core tenets about investing. This can be a little confusing when I write something on a Monday... and then Dan says essentially the opposite on a Tuesday.

However, God does not whisper in my ear. I can't be sure my ideas are "the truth." And in any case, Dan is not the kind of person who would allow anyone to tell him what to write or what to think. So we continue to respectfully disagree. However, to alleviate some confusion, I thought I'd touch on one point Dan made yesterday. (Dan, of course, is free to follow up again tomorrow.)

Yesterday, Dan said you shouldn't buy any stock unless you know you'd be willing to buy it if it fell 50%. I think this is utter madness.

We are not controlling investors in the common stocks we buy. We are outside, passive investors. Thus, regardless of SEC disclosures or how much homework we do, we possess a pretty limited amount of knowledge about any of the businesses we recommend. And even if we were to possess perfect knowledge of every business in our portfolio, we cannot peer into the future. Business conditions change – often far more rapidly than anyone expects.

While the market isn't perfectly efficient, it frequently knows more than you about the true condition of a company. And when a stock falls 50%, something is usually seriously wrong – sometimes something you simply couldn't know about.

The strategy of putting more capital at risk in a seriously losing position is absurd, in my mind, for outside passive investors. The idea goes against everything I've seen in this business and everything we teach our readers about how to limit the risks of owning common stocks. Such strategies frequently burn even the best, most knowledgeable investors in the world... guys like Legg Mason's Bill Miller, who has ridden an unbelievable string of losers all the way to zero.

For small individual investors, these kinds of losses would be utterly catastrophic. The only way to protect against them is to practice stop-loss discipline.

And finally, there are so many other ways to make good returns in stocks, it's simply not necessary to take on the big risk of buying a stock all the way down.

New highs: Anheuser-Busch (BUD), Plum Creek (PCL).

In the mailbag... Some of our readers think "eating the rich" is exactly the policy the government should be following, civil rights be damned. Send your thoughts here: feedback@stansberryresearch.com.

"Rich people pay too much in taxes! Yeah, right. That's about as worn out a concept as the poor people on welfare should all be put to work. While there is some truth in both these ideas, there are also a lot of misconceptions. For every statistic you can come up with about how bad the rich have it, someone else can come up with one that shows they are getting more than their fair share. So, let's use common sense to see if we can't find some truth. Who in the bottom 75% of Americans by wealth ownership, wouldn't want to change economic places with anyone in the top 2% and pay higher taxes? There's no way around the common sense notion that the distribution of wealth has become disproportionately skewed towards the top 2%-5% in the last 40 years. Why? Because capital has been elevated above labor. Fair is fair. Having 10,000 middle class people loose their jobs because some ridiculously overpaid CEO lost billions while pocketing millions, is not a good argument for reducing that CEO's tax burden. Is the tax code a mess? Do we all pay too much tax for the value we get? Yes, to both of those questions. The solution is not to pit the wealthy against the middle and below." – Paid-up subscriber John Diekmann

Porter comment: My argument has nothing to do with the amount of tax the rich pay, or the amount of tax we all must pay. Of course we all (rich and poor) pay too much in taxes. But if you want to see taxes lowered, you've got to equalize the rate of tax on all the voters.

The progressive nature of our tax code stimulates enormous growth in the government because it effectively allows a majority of Americans to live at the expense of a tiny minority. And that won't change until the incentives are changed. Once the burden of government is shared at the same rate, more people will consider the costs of what they vote for.

"Sorry Porter, but I hate to see you ranting about tax increases one day; and then you rant about deficits the next day. You either eat the cake and s**t it out or watch it spoil. I prefer to have a tax increase if it means a decrease in the deficit. The large current deficit is tantamount to 'taxation before existence' (future generations). Deficits are partially to be blamed for the miserable state of the dollar and all of its radiant parts... of the economy. Check out the Federal OMB's graph on the deficit and it's relation to the higher taxes of the Clinton Years. You may also want to overlay the dollar's performance against a 'basket of currencies' during this period." – Paid-up subscriber Bertram Val Crick

Porter comment: Again, my proposed changes – the three simple steps to fix America – have nothing to do with the overall rate of tax. And the first recommendation I made was to pass a balanced-budget amendment. As long as the government can spend without limits, we have no chance of scaling back the role of government in our society.

"Porter's March 2005 'No Risk' report and the textbook materials from the Monthly Dividend Program are easily the best I've ever read. I was undecided on the best way I should go for my age and financial resources. These reports have pointed me in the correct direction. I can now plan and feel confident that what I'm doing will give me the best results in today's economy..." – Paid-up subscriber Henry Z.

Porter comment: Thanks, Henry... I wish all our subscribers would at least try our Monthly Dividend Program. For most people, this is easily the simplest, safest, and smartest way to invest. Click here if you want to give it a try free of charge.

Regards,

Porter Stansberry

Baltimore, Maryland

July 30, 2008

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