S&A Digest: When to cover Fannie and Freddie

When to cover Fannie and Freddie... No, you can't short that stock... American "freedom"... Offended in Vegas?... A great restaurant... Porter rants...

Should we cover? That's the question I'm faced with every single morning. I recommended shorting Fannie Mae at $27 and Freddie Mac at $25. Subscribers who followed my advice are now sitting on huge profits (76% on Freddie Mac, 68% on Fannie Mae by Wednesday afternoon). These gains are critical to offsetting the other losses we've all taken on stocks this year. I still don't think the government will do anything directly to bail out shareholders, though I'm growing more concerned that indirect actions – such as the recent ban on short selling – may conspire to push up the share price. So here's what I recommend...

Set a stop at $10. If either stock gets back above $10, cover the short position. Yes, I still believe both stocks are zeros, but it's foolish to fight the government. Who knows what rule they'll make up next?

You always know real trouble is brewing when the government starts scapegoating short sellers. The SEC went so far yesterday as to make it nearly impossible for small traders to short any of the big financial stocks. Explaining the new aversion to betting on falling financials, the SEC told the Wall Street Journal, "Drastic falls can end up destroying confidence in the firm altogether, which is not for bricks-and-mortar industrial companies." Oh, really? Try telling that to GM.

The truth is plain enough to see. Bear Stearns didn't fail because of its stock price. It failed because it was leveraged 34-to-1 into mortgages. Likewise, Fannie and Freddie aren't going out of business because of short selling or their share prices. They're going bust because they're leveraged more than 100-to-1 into mortgages written against hugely inflated home prices. The SEC seems to forget that stock prices reflect a company's fundamentals, not the other way around.

The SEC's new ban on short selling financial stocks is a perfect example of the real U.S. government. The government says it's all in favor of freedom (free markets, free speech, a free Afghanistan, etc.). But the government is only really interested in freedom as a propaganda tool. The moment someone's vested interest is threatened, the truth comes out. The last thing the government wants you to have is freedom.

Fannie and Freddie are obviously in trouble, but Wells Fargo is doing fine. In fact, the bank raised its dividend 10% this quarter. Wells Fargo announced estimate-beating second-quarter earnings this morning, and shares jumped more than 32%. The largest bank on the West Coast saw earnings fall 21%. But its revenues increased 16%, and credit-card fee and insurance revenues also rose. Wells Fargo earnings have declined for three straight quarters, but the bank has remained profitable. These results show you how poorly managed Fannie and Freddie were. They had every government-granted advantage in the market... and still went broke. Wells Fargo remains profitable.

Bill Ackman made headlines this year shorting bond insurers MBIA and Ambac. He also announced a short position in Fannie and Freddie recently. But... investing in hedge funds has risk. Last year, Ackman started a $2 billion hedge fund to invest in one, secret stock. He raised all the money without telling anyone what he was buying. He bought Target, and shares are down 38%. Yet Ackman is still buying... and raising cash. When Ackman finds a stock he likes, he rides it all the way down. He did the same thing with bookstore Borders, which fell 78% in a year. We're not hedge-fund managers... maybe that's why we prefer to cut our losses.

As some of you know, I attended Mark Skousen's FreedomFest in Las Vegas last week. I will not be invited back...

At least some of the people who heard my talk – which focused on libertarian themes like equality before the law and the coming collapse of Fannie Mae and Freddie Mac – were deeply offended by some of the language I used to describe our politicians. (If you are easily offended... why attend FreedomFest in Sin City?)

Why did I use such colorful language? I am outraged at the actions of our government. In only about 40 years, the buffoons in Washington have destroyed the good credit and the good name of our country. They are well on their way to destroying most of our wealth, too. Our national politicians are, to a person, the most evil, vile, and unfaithful scum on this Earth. They are destroying our country for the sake of their short-lived desire for power. These men and women deserve the most disgusting things to be said about them. We owe them nothing but disrespect, which I heaped upon them with some fervor. I imagine most of you would have applauded my words. If you saw my speech, let us know what you thought of it: feedback@stansberryresearch.com.

One other tidbit from Las Vegas... We had the opportunity to eat at several of the finest restaurants in town, probably in the country. Doug Casey took us to Joel Robuchon – the fanciest place in Vegas. (It's rated three stars by Michelin, if that means something to you.) We ate at Steve Wynn's best restaurant, Alex, too.

But we had our best meal, by far, at Nove Italiano, which sits atop the Palms hotel. Manager Carmine Depasquale serves better food with better service at a far more reasonable price than any of his more famous competition. It's the only restaurant I'd like to go back to. When you go, make sure to order the big shellfish appetizer. It's the best I've ever had, anywhere. And after dinner ask the chef to bring out his homemade digestivo. It's a twist on the Italian classic liqueur, Limoncello. Only it's made with tequila...

New high: Baxter International (BAX).

In the mailbag... The critics have returned. And that's probably best. We were beginning to believe our own (good) press. Thanks. Bring us down to size here: feedback@stansberryresearch.com.

"Your recent comment on the SEC investigation regarding the rumor spreading against Bear Stearns is one of the most ridiculous analogies ever drawn by you. Any bank in the world will fall if you can ignite a sudden run on it. This is not about yelling fire in a crowded theatre. It is more like causing the fire in the first place. High leverage speeds up things, granted, but even at half the leverage Bear Stearns was doomed when CNBC spread the rumors (and they never really denounced them even while they were absolutely false). The same now seems to happen with LEH. Rumors get spread that Pimco stopped doing business with them – but Pimco categorically denies it. Looks like you are pretty much biased here - perhaps because Ferris is short LEH and you are short Fannie and Freddie? I for my part think the SEC should thoroughly investigate this and besides that all hedge funds should be required to disclose any material short position in a company instantly – after all, mutual funds have to disclose their long positions, too, so that would only be fair, not?" – Paid-up subscriber S.M.

Porter comment: You're wrong in every way. Let's start with the "rumors" about Bear Stearns. The facts are: Pimco threatened to pull its capital and stopped trading with the firm last December. So telling people Pimco had lost faith in Bear was only telling the truth. Should the SEC forbid people from telling the truth? Second, the stock price of these banks has NOTHING to do with their solvency or lack of solvency. If Lehman really is sound, then folks are getting a great opportunity to buy it. That's the way the market should work. When you're right, you make money. When you're wrong, you lose it.

We object to the SEC trying to pick winners and losers instead of letting the market sort it out. If Lehman's board of directors wanted to raise the share price – and if its business really is sound – it could initiate a big stock buyback or raise the dividend, like Wells Fargo. If the business isn't sound, then a collapse will occur sooner or later. And no SEC investigation of "rumors" will prevent it. As far as our bias goes, we aren't allowed to own positions in our recommended stocks, so in cases like this, we can't be accused of being "biased." Our only interest is to provide actionable (and profitable) advice to our subscribers. If we're wrong about our predictions, we'll go out of business. If we're right on our predictions (at least most of the time), our business will grow. We're shooting for the latter.

"I really do enjoy reading your rants. They provide a breath of fresh air in the world of total B.S. I am reminded of an old acquaintance in Alaska. John was an old mercenary, having spent some time in various African jails. John was taking Mandarin Chinese at the U of A. I asked him why. He replied that he wanted to read the labels on the ammo boxes as they went by in the next war. You help me read the labels. Hell, a title don't mean dodo. G.W.Bush has an MBA from Harvard. As an old lady in Midland, TX once said when GW was running for President, 'George is a nice boy, but he ain't ever made a dime in his life.'" – Paid-up subscriber D.G. Husek

"Porter, since you believe silver will skyrocket, how about some thoughts regarding purchasing silver on margin. I believe it's the best way to max the returns for hogs like me." – Anonymous

Porter comment: Jeff Clark recently recommended an options play for silver in his S&A Short Report. He believes you can nearly triple your money on this trade. Buying these options will juice your returns without having to buy on margin. To learn more about the Short Report and receive Jeff's silver options trade, click here...

"Up 45% on BUD since buying in November 2006 per Porter's recommendation. Only with 2% of my portfolio though, not the recommended 25% limit. A brilliant newsletter writer told me that such a large allocation to any single stock is a good way to blow up your portfolio (Source: Porter Stansberry, different day). Discipline matters, even when you're right." – Paid-up subscriber Robin

Porter comment: Yes... But sometimes you've got to break your rules. Like maybe once every 10 years. The BUD recommendation was the first time I'd ever recommended a position size more than 10%. I'm glad it worked out. And I'm especially glad many subscribers have done well with it.

Regards,

Porter Stansberry

Baltimore, Maryland

July 16, 2008

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