The S&A Digest: A Whiff of Panic...

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

As of 06/27/2013

A whiff of panic… Buffett is buying… Soros is, too… The Chinese take a big hit… What to do now… "You're incompetent"… Why not endorse Ron Paul?

When I saw Brian Williams lead NBC's evening news program last night with a segment about the mortgage meltdown, I knew today's stock market opening would be very bad. When I heard that Countrywide couldn't sell commercial paper and had drawn down its lines of credit to the last penny, I thought we might see a complete collapse in the stock market – perhaps a one-day fall of 10% or 15%. Although the market wasn't as bad as I thought it might be early this morning, watching the futures markets and the CNBC broadcast brought back memories of 1997, 1998, and 2002. I could feel the panic.

Am I worried? Of course. My publishing business depends on the public continuing to be widely interested in buying stocks. On the other hand, if you're an experienced investor, you live for times like these… As Kilgore said in Apocalypse Now: "I love the smell of napalm in the morning... The smell, you know that gasoline smell… Smelled like... victory. Someday this war's gonna end..."

Real investors use market panics to take big positions in great businesses they understand. We've been waiting for the right time to buy – in some cases for decades. Case in point: Warren Buffett has been pouring capital into this market already. According to a Tuesday filing with the SEC (reflecting purchases through June 30), Buffett's Berkshire Hathaway has added significantly to its stakes in WellPoint and UnitedHealth (the two largest health insurers in the U.S.). Buffett also increased Berkshire's holdings of PSIA pick Johnson & Johnson (JNJ) by 9.2% and quadrupled its holdings of drug-maker Sanofi. You might be surprised to know that neither the real estate panic nor the mortgage problems scare Buffett: He took his first position in Bank of America, buying 8.7 million shares, and increased Berkshire's position in Wells Fargo by 11%. He also bought more U.S. Bancorp, increasing his stake by 59% to 37.1 million shares.

And here's another example: George Soros has taken positions in S&A Oil Report pick ConocoPhillips (COP) and S&A Gold Report pick Freeport McMoRan (FCX).

Every time we write anything about Soros, we get dozens of cancellation notices. Apparently many of our subscribers believe George Soros is actually the devil in disguise and is secretly responsible for every problem in the world. Before you send us an angry note, please take notice: We don't report on Soros' political activities, and we don't write about his wacky philosophical posturing. We only follow what he does with his money, because, like it or not, he is one of the very best speculators in history.

On the other end of the spectrum… you've got the Chinese. Remember the Chinese government's $3 billion investment in private-equity firm Blackstone right at the top of the market? We estimate they're down $700 million… in about six weeks.

What should you do in this market? Ideally, not much. If you're well diversified and holding mostly safe stocks bought at good prices, you'll probably see your portfolio fall 10%-15% in price through this correction. But the value of your holdings shouldn't actually change very much, and you shouldn't need to make too many, if any, changes. We recently published a list in The Digest that featured our best, safe ideas. Keep an eye on these stocks. If the market experiences the kind of day I think might still be coming – a day of real panicked selling – then step up and buy a few more shares in several great businesses. I'd plan on buying into this market over the course of 12-18 months. Don't worry about trying to catch the bottom… just keep on picking up top-quality companies at good prices.

In the mailbag, an angry customer wants to know: Why don't we manage money instead of only writing about stocks? As we explained yesterday, we've been expecting a barrage of angry letters. When stocks fall sharply, people who were taking on far too much risk get hurt… and they've got to blame someone. We're the perfect targets. The good news is, great investment opportunities are directly correlated to the volume of our "hate mail."

It's sad and ironic. But that's the way the markets work: You should be buying when others are afraid. You should be selling when others are overconfident. Good or bad, we read all of your notes. Send yours here: feedback@stansberryresearch.com.

"Your writers are for the most part a bunch of incompetent people. Your writers can't trade to make a profit, so they write subscription letters. If you were the least bit qualified and believed your own selections, you would be buying your picks along with your subscribers. But you don't do that because you would lose money, so you encourage your subscribers to buy your selections and if they lose money, it's just too bad… You have no credibility, and I for one have stopped buying any stocks you recommend since you don't know crap about stock selection... Try trading/investing yourselves and provide subscribers some independently, verifiable results to show us you are indeed capable and not just full of hot air." – Paid-up subscriber Richard H.

Porter comment: You've got it all wrong, Richard. First, several of our analysts were professional money managers – and they did very well at those jobs. And one of our writers continues to manage a private fund as a side business. We don't write newsletters because we can't run our own money.

So, why write newsletters? Most people don't understand that the business of money management isn't all about researching stocks and making good investments. Much of a money manager's time is spent holding clients' hands and raising additional funds to manage – customer service and marketing, in other words. Our editors don't have to do either of those things, so they can focus strictly on researching investments, which is what they love to do. This focus on research allows us to recruit experienced money managers: They're tired of customer service and marketing, and they just want to pick stocks.

On the other hand, we have hundreds, if not thousands, of money managers as subscribers. Why? Because as they tell me directly, they're so busy with customer service and marketing they don't have time to do their own research.

Finally, your supposition that we don't buy the stocks we recommend is completely false. For legal reasons, including SEC regulations, we don't allow our editors to buy the stocks they write about. We also simply prefer to offer advice in a completely independent fashion – unlike Wall Street analysts, there's no question about our motives. However, we are allowed to buy the stocks other editors recommend, and I believe all of the editors in our group (and many of our other employees) frequently buy the stocks covered in our various newsletters.

In my own portfolio, I buy almost exclusively the stocks my analysts have covered. I'd be a fool not to. This year, by the way, I'm up about 12%. I run a very focused portfolio of between four and six stocks at any given time (which I don't recommend for most investors). Currently, my personal portfolio is 25% in cash, 45% short, and 30% long. I'm short stocks that are highly indebted, and I'm long cash-like vehicles and gold-mining stocks.

"As John Mauldin recently pointed out, the traditional relationships between the various risk/reward offerings of companies have been twisted recently. Normally, senior notes (those which get paid back first in the event of a bankruptcy) are more highly valued than preferred/subordinated, which are more highly valued than common shares. Doug Casey (Casey Research) and his staff have recently made similar points about senior securities. U.S. markets are having a very nearly indiscriminate fire sale on senior securities. Many funds are facing redemptions that require that they sell something. At least some of those funds are finding the only thing marketable is senior notes, so they must sell them for what they can get. That means that many senior notes are now selling at substantial discounts to their probable value. The risk is that a company's senior securities might be down because that company may go bankrupt. Yet the general market mood has driven the senior securities of strong companies down along with those of more risky companies. This seems like an excellent opportunity, yet markets may have further to fall…

"As an example, Realty Income (O). The common stock made 52-week lows 01 Aug 2007 (and 01 Aug 2006, interestingly). The common stock (O) pays a little less than a 6% dividend and is up about 15% from the recent low. The senior notes (OUI) that pay a 8.25% dividend, made a 52-week low 30 Jul 2007... Yet, OUI has moved up only a little (3%) from that low. I realize that given the low volumes OUI trades [at], The 12% Letter probably has too many subscribers to recommend the trade. By the way... best wishes in weathering the string of stopped-out recos !! I wouldn't want to be reading some of the other e-mails you are probably seeing." – Paid-up subscriber Scott Maley

"Despite the recent market turmoil, I still enjoy reading the various bits of advice offered by your various writers. Sometimes I follow the advice given. Sometimes I don't. I continue to learn from the experience, and I hold myself responsible for investment decisions. When I got involved with stocks a few years ago, I made sure I spread out my risks by investing in a variety of solid companies with a stress on good dividend payouts. I did get too greedy on occasion, but kept my losses small. Last fall's remarkable drop in Canadian gas/oil trusts (down about 30% in a few days) prepared me for the fun we're having now. I kept almost all those trusts in my portfolio because I knew the companies were solid and the high dividends would keep me ahead of the game. And when I planned my household budget for this year, I assumed that my income would drop due to my exposure to commodities. Of course, I wasn't too happy to lose a few thousand on AHM. But when I hear that phrase, 'hold your nose,' I will give additional thought to the advice offered. I learned quickly from AHM – I dumped my Indymac immediately with scant losses. (Another solid outfit knocked down by the credit crunch). Keep it coming... including any group analysis about the bottom of this fall." – Paid-up subscriber Win Bissell

"Porter – My sincere compliments on [Tuesday's] S&A Digest – it's the best explanation I've read in one place of how the subprime mortgage mess has impacted the rest of the mortgage market, and the credit markets as a whole. This episode also is a great object lesson in the importance of 'not arguing with the market' when prices move in a way that confounds your investment thesis. Very often, the fundamentals become clear only after the market has moved." – Paid-up subscriber Dan Fylstra

"This is an excellent description of what is going on in the mortgage and asset-backed securities industry. I think you should also mention that something like one half of the workforce in the U.S. is in finance generally and a pretty big chunk (20%?, 10% of total?) of that in mortgage finance… [T]here are also probably around 5-10% (of total) in residential construction and remodeling/repair. I told you several months ago that a hard landing in [real estate] would threaten to bring down the likes of Wells Fargo (and behind that... even Berkshire Hathaway). This is a MUCH bigger problem than almost anyone understands right now. Unless the fed bails them out, I suspect that Bear is done. Goldman may be done. The problem is classic Soros reflexivity. Not only did capital flow into mortgages, but labor did, too. As [real estate] values plummet, there is no longer any engine in the U.S. economy. As significant numbers of people lose their jobs in mortgages, [real estate] values plummet further. It is nowhere NEAR over yet. Ammunition, canned goods... and if you must have a monetary-type investment, gold, I suppose."

– Paid-up subscriber Jim Perkins

Porter comment: We can't vouch for subscriber statistics... but according to Standard & Poor's, financials comprise 21% of the S&P 500 Index (market weighted). Historically it's more like 10%.

"Thank you for the Mortgage Crisis letter. It answers my Aug 10th query. 'Wait until the dust settles,' Oh Tay! Thank you all for the trailing stops. Mr. Buffett will get his chance to put all that cash to work after all won't he! A bubble like 2000? What an opportunity for the world to buy into the USA at a huge discount. So, what's next? Should or can the government step in and stop the carnage or let the market shake out the chaff? Damage control? A train wreck in slow motion... let's see, Scotch or Whiskey?"

– Paid-up subscriber Barry Lewis

"You do nothing, afraid to act, closed-minded defeatist. Of course, Ron Paul will lose because of people like you. You are a first-class wordsmith, so why not go to www.ronpaul2008.com and volunteer your talents. Instead of fly-fishing, write an article for the election of Ron Paul? He is our best chance at a better future. Instead of doing nothing, which guarantees the election of a big spender, get involved. Or would you just rather whine about it?"

– Paid-up subscriber Larry

Porter comment: I stay out of politics in public. I don't want to encourage them… or embarrass myself. Whether Ron Paul would be a good president or a bad president, I can't say. All I know is Ron Paul is the only honest politician in Washington… and that should count for something.

Good investing,

Porter Stansberry

Baltimore, Maryland

August 16, 2007

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