The S&A Digest: A new riddle

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/24/2013

A new riddle... A battle for uselessness in Washington... Another big downgrade coming... GM: Wait another three years, please... Maybe we should learn Arabic... President Trump?... Questions from an 'old fart'...

Before we get to the serious stuff, we have a riddle to share: Which mammal can run the farthest without stopping?

Look for the answer in Monday's Digest.

(At one time, riddles were a regular feature of The Digest. But nothing is more boring than a lame riddle. And, frankly, we simply ran out of good ones. If you have a good riddle, please, for the love of God, send it to us.)

President Bush is proposing to return $145 billion to taxpayers, in order to stimulate the economy. Not a single media commentator has thought to ask the obvious question: How can the government "give back" what it has already spent? As I mentioned recently in these pages, as a nation, we continue to save nothing and spend far more than we earn. So, we're borrowing money from our kids and grandkids (and probably ruining our nation's credit rating) all so we can continue to pretend that it's possible to live beyond our means forever. You don't have to be a genius to figure out this will end badly.

One more thing to consider: You can be sure the $145 billion that's disbursed won't actually be returned to the folks who originally paid for it in taxes. These tax "rebates" are actually a direct redistribution of income, courtesy of the feds. Now... where in the Constitution is that power given to Congress? Americans are going to get what they deserve from this insanity. And, if you're wise, you'll do whatever you can to get out of their way.

Not to be outdone for uselessness, Henry Waxman's House Committee on Oversight has scheduled a public whipping of the CEOs whose companies have collapsed in the mortgage crisis, including Countrywide's Angelo Mozilo, Merrill's Stan O'Neal, and Citigroup's Chuck Prince. Nowhere on the agenda is any discussion of Congress' role in promoting subprime lending to encourage low-income home ownership or the Fed's role in promoting the real estate bubble via ultra-low (1%) interest rates during 2002, 2003, and 2004.

While Bush kites checks and Waxman eats the rich, the housing crisis is expanding: Bond insurers MBIA and Ambac have a more than 70% chance of going bankrupt, according to credit default swaps. Moody's is threatening to cut its AAA ratings. A ratings cut would mean huge losses, approximately $200 billion, for the company's $2.4 trillion of insured debt. And it would cause even more damage to Wall Street banks, which own enormous amounts of "insured" bonds.

For example, Merrill Lynch, which has already written off $12 billion in CDOs (securitized mortgages), holds another $30 billion of such assets, $14 billion of which is insured. A lot of these CDOs are backed with 2006 mortgages, which have an estimated 20% default rate. Also noteworthy is that these securities don't trade regularly anymore, which means Merrill values them for $30 billion... but doesn't know exactly what they're worth. Merrill's CFO says only they estimated the value "as best we could."

Our bet is one of these big banks will fail, completely, before this crisis has passed. And we wouldn't be surprised if the firm that collapses is Merrill. Like E*Trade, it might eventually be bought for pennies on the dollar.

GM CEO Rick Wagoner is a pitiful businessman. But it takes a special person to con investors so artfully. He should have been a stockbroker! He told The Wall Street Journal GM would see "significant" profits in "two or three years." We wonder if the reporter laughed out loud when Wagoner spoke. That's the same thing Wagoner promised back in 2005 when his turnaround program began. Back then, GM's debt hadn't been downgraded to junk status, its finance company (GMAC) was minting money by dealing in subprime mortgages, and gas was still less than $2 per gallon. So far, Wagoner's turnaround plan has cost the company nearly $50 billion in losses.

Also not mentioned in the Journal article: The company's own accountants don't believe GM will ever regain profitability, which is why they wrote off most of GM's tax losses last quarter. If the U.S. slips into a recession this year, GM will go bankrupt within 18 months.

How much more of America will the Arab nations buy? We can't know for sure, but the Institute of International Finance estimates the Gulf Arab states will own more than $2 trillion in net foreign assets by year's end. Forget about teaching your children Chinese...

Of course, the buying power of the Gulf depends on oil prices. How long will they stay high? Until Donald Trump becomes president. In an interview with Fox News, The Donald outlines his foreign policy for oil:

Trump: If I were president, you'd have $30 oil right now. I would call up Saudi Arabia and say "That fing price is coming down, and it's coming down now." And you know what? They'd lower that price so quick, and it would be so easy.

Fox: What if they didn't?

Trump: They will. They will.

Watch the full interview here... (Search for "Trump talks".)

SPECIAL REQUEST: We're doing new research on companies that pay monthly dividends. (About 200 large companies pay dividends every month.) As part of this effort, we'd like to hear from individual investors who have benefited from monthly dividend payers. If you've invested in a stock that pays a monthly dividend and had good results, please tell us about it. Keep in mind: We value your privacy and will not include your real name in our printed publication. Also, if we use your story, you'll get a copy of our upcoming research report, FREE of charge. Send your brief story to: mpalmer@stansberryresearch.com.

New highs: none.

In the mailbag, we haven't seen any real rage or desperation yet, as is typical during a market correction. (Ironically, people seem to get fed up and to give up in droves at the precise bottom in the stock market.) If you're giving up on stocks (or just our letters) please be sure to drop us a line so we can keep tabs on market sentiment: feedback@stansberryresearch.com.

"I am an original subscriber to Dividend Grabber. I just finished reading your latest newsletter about [the new recommendation]. I guess I am really slow as I did not understand what I would gain from the spinoff. If I buy shares of [the new recommendation] and the spinoff occurs, do I get shares of [the spun-off subsidiary]? And if so will the price... decrease substantially? Please help!!" – Paid-up subscriber Roger Howe

Porter comment: The logic behind "grabbing" large dividends or big spinoffs is simple. Most companies aren't valued by the net tangible assets on their balance sheet. Thus it's possible for a company to pay out "special dividends" – large, one-time cash payments – without permanently reducing its market value. That's why it is possible to "grab" the special dividend. Yes, the stock price will decline by the amount of the cash dividend on the day it's paid, but then the stock price should rebound to where it was prior to the dividend being paid, assuming other factors (revenues, earnings, market multiple) remain the same.

No real difference exists between a special dividend and a spinoff. Most conglomerates aren't valued by the sum of their individual businesses, but instead by the earnings of the entire group. From time to time, subsidiaries inside conglomerates are simply ignored by the market – typically because the business in question is out of favor. When that happens, conglomerates can spin off the business in an IPO in order to generate cash from the subsidiary. And rather than selling all of the shares to the public, paying a tax, and then paying out a cash dividend (which might also be taxed), it simply makes more sense to distribute shares directly to shareholders on the day of the IPO. This is called a "spinoff." But it's the exact same thing as a special dividend. The only difference is, to get the cash, you have to sell the shares you've received in the spinoff.

In this case, a major conglomerate is spinning off a big business that's currently being ignored by investors. We believe the market value of the conglomerate won't change much, if at all, following the spinoff. And we believe the spinoff alone will generate a 20% profit for buyers of the conglomerate today. We see this as a very good, low-risk investment within a short and relatively defined period of time.

"Buffett had challenged his corporate [peers] to admit they all, as he, pay lower tax rates than their secretaries. Obama used this in Nevada to much "middle class" focus group applause. $48 million was Buffett's annual earnings quoth Obama. As the lone middle class voice at the water cooler for free markets, low taxes, less government, and personal responsibility I get this kind of crap replayed to me allot lately. As I watch Republican debates I'm assured it's bound to get worse. How do I reply to Buffett/Obama? A little help please." – Paid-up subscriber Kris

Porter comment: Kris, the argument that Buffett pays less in taxes than his secretaries might be factually correct, but it's utter nonsense in the context of our current tax code.

Our present tax code is dominated by income taxes. To earn income requires that you receive a salary. Buffett derives the overwhelming majority of his net worth from ownership of Berkshire Hathaway stock. As Berkshire doesn't pay a dividend (and Buffett only accepts a small, token salary), Buffett receives very little taxable income. Buffett might have made $48 million last year in the form of appreciating Berkshire Hathaway stock (or even more), but until he sells those shares, he won't trigger any taxes.

The reason this argument is nonsense is because if Buffett did require the capital he earned last year and he decided to sell shares equal to the $48 million, he would have to pay capital gains taxes of about $7.2 million. That's probably 100 times more money than his secretaries will make in their entire lives. Meanwhile, Buffett has decided to leave his estate to charity, so it's likely that Buffett will never pay much, if any, tax ever.

This situation does point to one critical weakness of income taxes: The truly rich don't pay income taxes because rich people don't often have much income. They don't typically have a regular job that pays income, and they're smart enough to set themselves up with various legal ways of using their money without triggering taxes. That's why when you see presidential candidates promising to tax the rich you know they're lying. You can't tax the very rich using income taxes. Increasing income taxes only reduces social mobility, making it much, much harder for average people to become wealthy via savings.

"Porter, I am what many people would call 'AN OLD FART.' Several years ago, I subscribed to a newsletter called Strategic Investment authored by James Dale Davidson and published by a company called Agora out of Baltimore. When I began to subscribe to one of your newsletters, I wondered about Agora as a connection... Davidson put me onto some very good investments. I am still invested in Lakehead Pipeline (now called Enbridge Pipeline and paying 7.3%) and Canadian Oil Sands. Canadian Oil Sands was selling for $12.50 a share I bought as much as I could. A few years ago, it split five for one and still was over $30.00 a share. Tonight I put the name James Dale Davidson into Google and found myself in an astonishing setting. I spent about an hour reading incrediblethings about Davidson allegedly touting penny stocks that were frauds. I also read copious references to such nefarious characters as Porter Stansberry, et al associated with 'Agora.' I fear may have stumbled into a 'Vast Left Wing Conspiracy' (apologies to Hillary Clinton) complete with dark plots, intrigue, black helicopters. Paranoia Incorporated!! I wonder if 'Independent Media Center' is not a euphemism for the far left underground. If you ever get the time, please explain all this to me and give me your age." – Paid-up subscriber Jim Fisher

Porter comment: I can answer only one part of your question with much certainty. I am 35 years old. As for the rest, it beats me. I don't know anything about Jim Davidson's business affairs. I've never worked with him, and I've only spoken to him in passing when I've seen him at various investment conferences. Is Davidson a bad advisor? Like most things, I guess it depends on whom you ask.

Regarding Agora Inc., I can answer plainly that Agora is a holding company that owns dozens of different businesses around the world. It is focused mostly on publishing and acts something like an "incubator" for lots of different kinds of publishing companies. Back in 1999, I cut a deal with Agora to help launch my own publishing company. Bill Bonner, the chairman of Agora, is a friend of mine and has been one of my most important mentors. That said, I run Stansberry Research with a completely free hand and all of our dealings with Agora are conducted "at arms length." I am not a shareholder of Agora. So... what's the connection with Jim Davidson? At one time, Jim Davidson's newsletter was published by a subsidiary of Agora and at one time Jim Davidson was a shareholder of Agora. In the minds of some people, the fact that one of the world's largest publishing companies has ties to two large newsletter writers constitutes a conspiracy. But I've never understood it.

Regards,

Porter Stansberry

Baltimore, Maryland

January 18, 2008

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