It's difficult for most people to understand how the market environment could have swung so quickly from a deflationary collapse to a new, inflationary boom. Two months ago, leveraged financial institutions of all stripes (banks, REITs, capital companies, hedge funds, etc.) looked like they were dead in the water – unable to refinance, unable to roll over debts, and unable to raise new equity. But today, despite the news that the banking system needs hundreds of billions of additional capital, banks and heavily leveraged firms are raising billions in new equity, at higher and higher prices. Why? What changed?
The answer is simple: the largest fiscal and monetary stimulus package ever engineered. If you combine the amount of deficit spending with the growth in monetary reserves, the government has pushed 30% of GDP into the economy over the last six months. That's 10 times more stimulus than the average policy response to all of the recessions after World War II, according to James Grant of Grant's Interest Rate Observer. There's an unprecedented amount of money being pumped into the financial system.
What does this mean for the markets and for our currency? Here's what I told my subscribers to expect:
The enormous growth in the Federal Reserve's balance sheet and the unprecedented increases to the federal deficit mean a new hyper-inflationary period is just around the corner... I don't know how long the transition from our current deflationary panic to the next inflationary crisis will last... but I know it must occur. You cannot have a lasting deflation with a worldwide paper reserve currency because nothing limits how much money the government can create or constrains what it's allowed to do with it.... The only real question is how much damage will occur when the inevitable inflation arrives and people realize it's not safe to hold dollars or lend at fixed interest rates? – PSIA, January 2009
The easiest way to profit from the ongoing destruction of the U.S. dollar is the most obvious: Sell long-term Treasury bonds, which will surely fall in price as the holders of government debt realize the value of our currency is being printed into oblivion. In my newsletter, I've recommended shorting a long bond ETF. We're up 18% since January – that's a big profit shorting bonds. Interest rates are going higher – a lot higher. You can see for yourself how poorly government bonds have performed this year:
Wall Street is catching on to the new trend. "We've seen the evidence of the beginning of a bear market in Treasuries. They are certainly losing some of their haven status," said Steve Rodosky, the head of Treasury and derivatives trading at PIMCO.
What's driving down bond prices? Enormous amounts of new government debt. According to Goldman Sachs, the Treasury will sell a record $3.25 trillion in debt this year. The most recent attempt, yesterday's $14 billion auction, didn't go well. Thirty-year Treasuries fell the most in six months... bonds sold at a yield of 4.28%. Yields on the 30-year Treasury rose to a near six-month high of 4.34% yesterday from 3.55% two months ago.
Surely no one from "Government Sachs" – the investment bank whose alumni control every powerful financial position in government – would use his power for personal profit? The chairman of the New York Federal Reserve, Stephen Friedman, resigned his post after disclosure of a "small" conflict of interest. While Goldman Sachs was appealing to the government for $5 billion in emergency funding last year, Stephen Friedman – the man who would eventually give Goldman the money it needed – was buying 37,300 shares of Goldman. He booked a nice $3 million profit from his Goldman "trade."
We discovered this because, as chairman of the New York Fed, Friedman had to report his trading to the SEC. A report about the situation in the Wall Street Journal led to Friedman's resignation today. Incredibly, the government had already granted him a waiver, allowing him to keep the money. Don't you wonder how many Goldman-connected trades weren't reported to the SEC? Don't you wonder how many people in powerful places have helped cover up the egregious accounting irregularities at the government's investment bank?
We enjoyed a small and brief amount of fame (or at least notoriety) last summer when I was the first financial analyst to report Fannie and Freddie's shares were certainly worth less than zero. My calculations revealed the combined net worth of both firms was around negative $500 billion. (This was while both stocks were trading in the $20s).
Today, Fannie reported it lost $23.2 billion in the most recent quarter and asked the government for an additional $19 billion to stay afloat. The company's book value (the difference between assets and liabilities) has fallen from negative $9.4 billion on September 30 to negative $18.9 billion today – more than doubling in seven months. Many more losses are yet to come. The company nearly doubled its loss reserves from the previous quarter to $42 billion. Just $200 billion or so more losses to go...
A bit of good news from my newsletter's portfolio... my top pick for 2009 has already doubled.
The market clearly expects demand for electricity to fall sharply this year, which could reduce Calpine's earnings materially. But Calpine's management team doesn't seem worried. In fact, despite a weakening economy in 2008, Calpine's revenues grew 25%... A business like Calpine's – that features a well-protected competitive advantage in a commodity market – producing roughly $500 million a year in free cash flow, should be worth something between 10 and 20 times that number, or $5 billion to $10 billion. Meanwhile, you can buy the stock today for about half of book value, or around $2.25 billion... Calpine's stock is an absolute steal at these prices. You should double your money on this stock, as it will surely trade at least at book value once the panic fades.
And if the company delivers on its expected earnings and cash flow, I think we'll see Calpine trading around two times book value, or $8 billion in market cap. That would be 16 times free cash flow and more in line with its peers. It would put the stock at $18 per share. Today, it's at $5.25... Calpine has to be one of the best, safest opportunities I've ever seen in my career. – PSIA March 2009
As I write, Calpine's stock is up $2 today to $11.57. Management reiterated its earnings forecast and reported better-than-expected revenues and earnings. At curre
nt prices, readers who bought on my recommendation are now up 124%.
Tom Dyson just dropped us a note about his latest Penny Trends pick:
Get ready for a new service to appear in the Top Ten. My latest Penny Trends recommendation, Boyd Gaming, is up 55% since our recommendation just two weeks ago. Two of our in-house beta-testing picks, Venoco and Anooraq Resources, have more than doubled (up 120% and 150%, respectively).
There's no better way to make enormous returns in an inflationary boom than owning microcap penny stocks... especially those in the natural resource business. My good friend Doug Casey made a fortune owning these things back in the 1970s... and our editor in chief, Brian Hunt, is putting his trading expertise together with Tom's to bring you the very best small-cap trading service. We're extremely confident you'll do very well this year with Penny Trends. Currently, Penny Trends is only available to our S&A Alliance members... but we're rolling it out to the public later this month. Watch this space for details.
New highs: Calpine (CPN).
In the mailbag... bitching about The Digest. Come on, it's worth every penny you paid for it... Send us your complaints. Or your praise. We read both: feedback@stansberryresearch.com.
"[The Digest] is basically one big whine job. The world is not coming to an end. Equity is being raised to retire debt at a discount and the economy is improving. All of which benefits disproportinally the equities of companies which were once thought insolvent. Instead of being wed to your melt down scenario, why not help us take advantage of it and not by your silly tirades about the dollar and wanting to move to Mars. Have you seen the beginnings of bull markets before? It does not sound like it. You might be smart but you really need some seasoning." – Paid-up subscriber Tom
Porter comment: Dear sir, I kindly suggest reading our newsletters. While it's certainly true we did well shorting overleveraged stocks last year, I've been writing in detail for several months about why an inflationary boom would surely follow in 2009. Since December 2008, I've recommended no fewer than 11 stocks whose shares are highly correlated to inflation, including a troubled insurance company, a blown-out shipping firm, a highly leveraged mortgage company (not Annaly), high-yield bonds, a railroad, gold-mining stocks, an oil-service firm, and a power generation company. These picks are now up, on average, 43% – far outperforming the stock market.
"Congratulations on your response to Frankie Rader... If this good old US of A was any other country were it's new leader started ruling by fiat (executive order) rather than by changes in law, nationalized it's banks and largest industries, null and void the concept of a legal contract and devalued it's currency we would invade to re-establish to freedom of the people and overthrow the new leader. Uganda, Somalia, Latvia, Pakistan, France anyone please HELP. P.S. Please keep up the good work. I know a lot of your readers will band together to post your bail (or mine)." – Paid-up subscriber Tony Korody
Porter comment: When they come for me, it will be with a black bag and CIA private plane to who knows where... Clearly, we're financial terrorists.
"Tell Frankie Rader et al to read 'The Dream,' an essay in the book Fart Proudly a collection of lesser known works of Benjamin Franklin. He needs a lesson of what used to be, what was supposed to be, according to the Constitution/Bill of Rights. Then he might get a grip on reality." – Paid-up subscriber Jan P.
"You keep saying this over & over again – 'The top 1% of earners contributes about 25% of the tax receipts.' Income tax is taxed on income. If the top 1% earn close to 25% of the income, they should pay close to 25% of the taxes. I am sure this proportion will look much more rational when you look at the percentage of total income the top 1% make. My guess is that it's close to 20%. I wish you'd stop repeating this bogus comparison over & over again." – Paid-up subscriber Mukund
Porter comment: You are either really bad at math or just a terrible guesser. In any case, rather than guessing, let's use real data, OK? I prefer the IRS data from 2006, which was the last normal year for our economy. According to the federales themselves, the top 1% of wage earners in the United States earned more than $388,806 in 2006. There were 1.65 million citizens in this category. As a group, they paid $488 billion in income taxes. That was 40% of all income taxes. But they only earned 22% of all wages. In short, the marginal tax rates on America's top earners were almost 100% more than average. OBAMA! will increase the top rate these people pay – because paying 100% more than average just isn't quite "fair" enough.
We might argue about whether or not we ought to charge some citizens different rates of income tax. But if you'll take the time to read the U.S. Constitution, it's clear that progressive taxation is unconstitutional. Just read the 14th Amendment. It says the government "may not deny to any person within its jurisdiction the equal protection of the laws." That means the law can't treat one citizen differently from another – white or black, rich or poor.
If our Constitution weren't merely a dead letter, the equal protection clause – which was designed to prevent black people from being discriminated against by southern states following the Civil War – would now effectively prevent a black president from "spreading the wealth around" as much as he sees fit. History is nothing if not ironic.
Even if you think progressive taxation is a good idea and redistributing income ought to be the government's prerogative, I can tell you judging from history and the recent experiences of several different countries, when society expects 40% of the tax burden to be carried by only 1% of the population, bad things happen. The masses always demand too many services from the government – because they're not paying for them. And, eventually, the 1% that's paying leaves, quits working, or hides their income.
The result is always catastrophic, not only for the state but for the culture. Once people get used to living off the bounty of their neighbors, they're reluctant to go back to work. And they're angry about it. There's not much more dangerous to society than lots of poor, angry, and desperate people who have become addicted to entitlements. Think unionized employees at Chrysler and GM. Welcome to Amerika.
At the present time, America's income taxes are the most progressive of any major industrialized nation. That's not a contest we should seek to win.
Regards,
Porter Stansberry
Baltimore, Maryland
May 8, 2009