The Department of Justice sues e-book sellers... How being human works against investors... The hot market today: Government guarantees... How government guarantees backfire on bond buyers... The End of Spain?!...
Almost since Amazon came out with its first Kindle in 2007, I've had one of the online retailer's electronic readers, which allows me to purchase and read digital versions of an endless array of books. I never travel without it.
One of my favorite aspects of the Kindle is that electronic books cost less. I've paid less than $10 for almost every one of the hundreds of books on my device... and even gotten some books for free. So it struck me as a little odd that the Department of Justice is suing five e-book publishers for price fixing.
Turns out Amazon isn't named in the suit. The six companies being sued are all Amazon competitors: Apple, Penguin, Simon & Schuster, MacMillan, HarperCollins, and Hachette Book Group. Financial Times reports three of the publishers have settled out of court, leaving Apple, Penguin, and MacMillan to fight it out in court.
The suit alleges the executives of these companies met in "private dining rooms of upscale Manhattan restaurants" to develop a strategy for competing with Amazon's successful Kindle business.
If your competitors are fixing prices higher... and you're the dominator on the block... aren't they begging for you to use your greater scale to undercut them and put them straight out of business? Do we really need the Department of Justice spending tax money to sue e-book sellers? Won't the market take care of e-book prices just fine without their help? E-book sellers can meet in private and fix prices all they want. As long as Amazon isn't in the room, they're only screwing themselves.
Last week, our friend from across the pond, Dylan Grice (who is also an analyst at the major French bank Societe Generale) sent out a research note, observing that "[investment] losses have roughly twice the psychological impact of gains. We're hardwired to overpay for loss mitigation."
I think this fear explains a lot of the current enthusiasm for bonds... despite the securities' super-low yields.
Paying too much for bonds because you're scared of losing money in stocks can get you into a lot of trouble. Too much is too much, no matter how you slice it. Sooner or later, prices that were once too high fall and become too cheap... Stocks were too expensive in 1999. They were too cheap in 2002. Homes were too expensive in 2006. They're too cheap, or perhaps reasonably priced at last, in some parts of the country today.
And so it shall be with bonds. They were too expensive in 1946, with 30-year Treasurys yielding 2.5%. They became too cheap by 1981, when Treasurys yielded 15%. Once again, bonds are too expensive today. As the stock market has fallen about 3.5% below its recent highs, so have the yields on Treasurys and other bonds perceived as safe havens. (Yields fall as prices rise.) The 10-year Treasury bond is yielding 2% today. Even before taxes, your real yield (accounting for inflation) is negative.
The situation is as poetic as it is tragic... Aside from guaranteeing payment of principal and interest on its debt, our government, via the Federal Reserve, has also guaranteed to keep inflation running around 2% a year... which sorta kinda guarantees your 10-year Treasury interest payments will provide you with a real yield of 0% and that your principal will be worth less when it's paid back to you than when you lent it to the government.
Government guarantees are the hot item of the day... Investors see the Barclays iShares Mortgage-backed Securities (MBS) Bond Fund (which trades under the ticker MBB) as being nearly as safe as Treasurys, due to Fannie and Freddie's guarantees on the underlying mortgages. Though its monthly dividend has fallen from more than $0.30 a share in March 2011 to less than $0.21 this month... the share price has rallied sharply in the same period... rising from less than $105 to more than $108 today.
Perhaps you think there's no way anything bad could ever happen to mortgage bonds backed by ironclad government guarantees. But remember... When ironclad ships sink, they go down fast. One day, folks who rely on government guarantees to protect their investment capital will see it go straight up in smoke... and much faster than anyone would have believed.
But for now, government guarantees are worth more to investors than almost anything else. To compare valuations... you can express a bond's yield in terms of the standard stock metric price-to-earnings (P/E) ratio. To do so, you simply divide 100 by the yield.
So with the benchmark 10-year Treasury's yield around 2% today, you're essentially paying about 50 times earnings for a fully taxable income stream guaranteed never to rise and highly likely to be obliterated by inflation. Likewise, the MBS bond fund trades at an implied P/E of around 30 times earnings (i.e. a current yield around 3.3%). Those are exceptionally high valuations... You'd be leery of stocks trading at those levels.
But you know how people are. When they get scared, there's no reasoning with them. For the week ended March 28, investors pulled $4.43 billion out of equity mutual funds and poured $6.12 billion into bond mutual funds. This has been going on for a few years now, according to data from the Investment Company Institute, the research arm of the nonprofit trade association, the National Association of U.S. Investment Companies. It's like investors have given up on stocks.
I understand short-term investors keeping money in bonds. They can't afford to wait out dips in the stock market. That's rational. But if you can wait seven or 10 years before you need your money, there's something much, much better than bonds out there: High-quality stocks, a group that includes our favorite subset of the stock market – World Dominating Dividend Growers.
These are the big names like McDonald's, Microsoft, Coca-Cola, Wal-Mart, and Procter & Gamble. They tend not only to stay big and highly profitable... but to get bigger year after year. And they all pay higher and higher dividends year after year for decades on end. Procter & Gamble has paid higher dividends every year for the last 58 years. Wal-Mart has raised its dividend for the last 36 straight years.
All the stocks mentioned above have raised their dividends at a rate that will beat inflation. Treasurys and the MBS bond fund can't do that. Sure, if you need your money a few years from now, you might be better off in bonds than stocks. But if you need to grow your wealth over the long term, bonds will leave you in the dust. World Dominating Dividend Growers will compound your money at inflation-beating rates.
The May issue of The 12% Letter – where I discuss my portfolio of World Dominating Dividend Growers (WDDGs) – is due out next week. To get access to The 12% Letter and find what World WDDGs are trading below our buy-up-to prices today, click here.
Instead of the End of America, perhaps we should spend more time talking about the End of Europe...
Spain is the latest and biggest casualty in the European debt crisis. It's shaping up as the fourth European country in need of a bailout, after Greece, Ireland, and Portugal. Spain's 709 billion euros of sovereign debt is larger than the debt of those other three countries combined.
The government has taken to cutting services considered basic rights to most Spanish citizens, like education and health care. Spanish citizens are protesting in the streets. Demonstrations could turn violent as Spain's prime minister, Mariano Rajoy, continues cutting the federal budget.
Spanish stocks recently fell to their lowest levels since 2009, and Spanish 10-year government bond yields are approaching 6% (versus the perceived safety of German bonds, which now yield less than 1.8%).
As part of the European Union, Spain can't act on its own to devalue its currency to fix its debt problems. Neither can Italy, the next shoe likely to drop in Europe...
New 52-week high (as of 04/10/2012): Texas Pacific Land Trust (TPL).
Yesterday's bullets on commodities investor Jim Rogers and his predications about farming generated lots of feedback... Do you have experience in agriculture? How do you see the future of farming? Send your comments to feedback@stansberryresearch.com.
"The comments on your S&A Digest were a little unsettling for me. I walked away from farming in 1983. The thoughts farmers had then, and what read in the press, was that the world food needs were greater than production. Also, there was the thought that there would be no significant new acreages brought into production. I had an opportunity to put my name on the dotted line to buy some land and rent additional land. If I had taken that opportunity, I would have gone broke the very next year and reduced my net worth to $0.00. The lesson learned then was that world food needs and world food demand are not the same thing.
"I have heard of a farm in northwest Iowa selling for $20,000 per acre in 2011. If gross farm incomes continue to increase, we will see more land prices like that in northwest Iowa. Net incomes for farmers will not necessarily balloon. Suggesting that farmers will profit greatly from higher food prices is a myth. The farmer does not control the costs of his inputs or his outputs but he does put any increased income into higher land and rent prices. I have watched the average age of farmers increase in the past 40 years and am still amazed at how they still get the job done. Maybe I shouldn't be amazed. I am retired now and still do part-time work for a farm friend of mine.
"I appreciate the thought that the way farming is done will have to change but I don't even care to guess when and how whose changes will come about. We had those discussions at Iowa State University Extension council meetings back in the 1970s. The main change I see over the last 40 years is larger farms. If businesses that control farm input costs push too hard or government farm programs change drastically, there could easily be a bump in the longer term directions for farming. What's out there in farming today just reminds me too much of the late 1970s." – Paid-up subscribers Veryln and Carol Larsen
"I've been a subscriber for about 9 months now; and I have enjoyed reading your articles on the different financial sectors that makes this country function. I'm a 5th generation farmer from Scott County Iowa; and I will be 62 years old this coming August. I can remember my Father telling me years ago; every once in a while you've got to head to town and get some advice! With the Internet, you guys are close at hand, and I appreciate your views on the outlooks and trends of this country.
"I want you to know that I also believe this country is in trouble. The inflation that is taking place will eventually make poor people out of just about everybody! Two weeks ago I need 4 new semi tires. I bought the cheapest retreads I could find. Mounted and balanced they were $995 total. Yesterday I needed/purchased 4 rear radial 12 ply tractor tires with rims for just under $7000! Last January I attended a land auction which sold a 195 acre farm/180 acres tillable for $1,600,250. I purchased that property with a 1031 exchange. I have other property which I hope to exchange next year.
"In closing, I never would have thought 10 years ago that commodity prices would be where they are right now. For all the years I've been farming, it's been about working at something that I enjoyed, being your own boss, and making your decisions, learning from your mistakes! Whatever profits I do receive in the years' to come; I will invest in land. Thank you!" – Paid-up subscriber Mark Copely
"Love you guys, swear by you. I am an apple grower in upstate NY. Forever, planted orchard land sold for $12-1400 per acre. Open crop land at least for the past 20 years, was considered $500-$1000 per acre for its value. Now perhaps you already know that NY grows the best tasting apple in the entire country, but compared to the most dominant growing region (Washington state), land value was much less. But just recently, two different transactions in the heart of apple country in NY paid $5,000 per acre for existing but nothing great, orchard land. This is both good and bad. Bad because if I wanted to expand, it will cost that much more. Good, because what I own is worth that much more.
"I'm hopeful that my strategy to increase productivity and efficiency as well as planting highly desired varieties, and upgrading my equipment at the rate of 0% for 5 years and containing my debt will serve us well for the expected future inflation. Not to mention I love this life style and wouldn't trade it for anything. And even if I sold it for a lot of money, I would want to buy another one." – Paid-up subscriber Doug Fox
Regards,
Dan Ferris
Medford, Oregon
April 11, 2012