The S&A Digest: Buy When Investors Panic... Make a Quick 17%

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

As of 06/19/2013

Villa Reineri... Buffett vs. hedge funds... Porter vs. a subscriber?... Brian Williams, moron... Ballmer predicts newsletters 'kaput'... The Galt's Gulch cascade... Why Lehman blew up... The serenity index...

We arrived at Villa Reineri at 4 p.m. local time. The owner, Jacopo Bacci, was waiting, somewhat impatiently... which was ironic considering we were precisely on time despite a 14-hour journey across the Atlantic Ocean.

The villa sits on a small rise, in the middle of a huge valley approximately eight kilometers east of Montalcino. It is surrounded by vineyards, which grow Sangiovese grosso, the local clone of Italy's dominant grape. Mt. Amiata towers over the valley, rising to nearly 6,000 feet.

This is our first international trip with our nine-month-old son, Traveler. I can tell you... no one in the travel business likes children. Everywhere we go, we get dirty looks. But Traveler takes it in stride. He smiles briefly, puts his right thumb in his mouth... and goes to sleep.

What does my family's vacation to Tuscany have to do with you, dear reader? Perhaps nothing at all. But if you have any interest in Brunello wines, stay tuned. The last time we were here, our group "tasted" more than 80 bottles in about a week. After two days here, our cork pile is already more than a dozen strong. And unlike the wine press, I will tell you the truth about the vintages, the best wines, and the prices you should pay.

And... what if you have no interest in wines? Then if I were you, I'd ignore my ramblings about Italians and grapes and pay close attention to these two facts: First, the price-to-earnings multiple of the S&P 500 is currently 22. Second, the yield these stocks provide, on average, is only 2.2%. It is not a great time to buy stocks. But we seem to be moving in the right direction – assuming you hope to buy stocks in the future.

Last week in my newsletter, I published some facts I found shocking and truly worrisome. It's easier to avoid thinking about bad news... but it can be very expensive...

The delinquency rate for all residential mortgages at the end of the first quarter of 2008 was 6.35% – a record high. In addition, the percentage of mortgages in foreclosure is now 2.47%, up almost 100% from last year. Adding the two numbers together, you see that nearly 9% of all of the mortgages in the United States are either in default or in foreclosure. The Census Bureau reports that about 10% of houses built after 2000 stand vacant. This is unprecedented.

Looking at these facts and studying the books of Fannie Mae and Freddie Mac, I'm convinced both firms are bankrupt and their share prices will fall to zero. I made the same prediction at last November's Alliance conference. People laughed. The audience thought I was kidding...

Fortune reports Warren Buffett is making a million-dollar wager that a collection of hedge funds won't beat the S&P 500 over the next 10 years. The bet is with Protégé Partners, which manages investments in other hedge funds for its clients. It's a so-called "fund of funds." Buffett has been pointedly critical of these "investment helpers," claiming that paying such managers huge incentive fees dooms their investors to poor returns.

I'd like to offer a similar wager to an interested subscriber... Over the next 10 years, I bet the average return of my "No Risk" portfolio will beat the S&P 500, Berkshire Hathaway, and Protégé Partners' returns. I'm not as rich as Buffett or the hedge-fund guys, but I'm willing to bet $10,000.

Provided I'm allowed to make the wager (I haven't checked with our lawyers), I'll take the first subscriber who wants to be on the other side of the bet. And in 10 years, no matter who wins or loses, we'll donate the winnings to Baltimore's Habitat for Humanity. I'll update my progress each year when Buffett updates the public on the wager.

While I never suspected the pretty men who read the evening news of being geniuses, I must say I found Brian Williams' commencement advice particularly moronic...

Williams, admonishing Ohio State University graduates that they'll have to "fix" the country, suggested that they "start with climate." Having hired college graduates into my publishing company frequently over the last 10 years, my advice to college graduates is: Learn how to write a clear, simple sentence. Most can't.

The only brilliant advice I've seen offered to graduates wasn't actually given in a speech, but in a poem by Mary Schmich.

Today, Gazprom, Russia's gas monopoly, predicted oil prices would reach $250 a barrel in 2009.

The website www.energybulletin.net published a very thorough review of the U.S. military's use of energy. "The DoD's total primary energy consumption in 2006 was 1100 trillion Btu." Nigeria, with a population of 140 million, consumes roughly the same amount. But Nigeria is a major exporter of oil, while the U.S. is the world's largest importer. I wonder what the price of oil will be in the United States when countries begin to restrict petroleum exports in order to manage inflation in their economies...

"There will be no media consumption left in 10 years that is not delivered over an IP network," Steve Ballmer told the Washington Post. "There will be no newspapers, no magazines that are delivered in paper form. Everything gets delivered in an electronic form."

I doubt he's right. A majority of our subscribers prefer to have a printed copy of their newsletters mailed to them, even though they've already read the issue online. Paper won't go away completely, even as electronic publishing grows.

From today's Wall Street Journal: "...26-year-old accountant Shawanda Greene says she joined 'Girls Just Wanna Have Funds,' a recently created Washington, D.C., support group of mostly younger women. Ms. Greene's goal: to figure out why, despite an annual salary of $82,000, she had only $54 in her savings account."

Here's what I'd like to know, Shawanda: How did you convince an employer to pay you $82,000 per year for accounting when you can't even keep track of your own household budget?

In the mailbag... We hit the motherlode with Dan's recent rhetorical question, "Where's Galt's Gulch?" Apparently, a large number of our subscribers are ideologically sound. Send your feedback here: feedback@stansberryresearch.com.

"Porter's coming to Italy? Where, when?" – Paid-up subscriber Beppe Cloza; Florence, Italy

Porter comment: I spend two weeks a year in Montalcino. It's one of my favorite places in the world. If you love good food and wine, Montalcino is the center of the universe.

"Geeze!!! I'm one who holds George Soros in contempt as a leftest extremist who is a traitor to capitalism and all of what made America great, which is ironic considering he has profited from capitalizm more than about 99.9% of the rest of us. I would like to see him experience a very unpleasant capitalistic episode, but to wish physical suffering and death upon his family is beyond the pale of even a right winged capital punishment advocate. It is fun (and scary) to observe the degrees of expression your paid up subscribers will go." – Paid-up subscriber Charley O

"I would ask that you not publish threats of physical violence, torture, etc. They lack imagination and really don't have any place in a forum, which regularly exhibits intellect and insight. We live in a truly violent world, where people are killed, tortured, permanently damaged for their beliefs or way of life. Please don't demonstrate your tolerance by allowing this type of diatribe to make its way into our forum; you encourage by inclusion, feel free to rant against it but please don't include it as a legitimate approach to voicing ones disagreement with another." – Paid-up subscriber WB Gregory

Porter comment: We don't make up these e-mails... Folks really do write outrageous things to us. Even when we find their words deeply offensive, we publish them. Why? It's not because we support their views, especially when they espouse any kind of violence. We publish their opinions because we think it's important to remind our audience this kind of hatred and bigotry is still common in America.

"Dear Porter... You wrote a very impressive letter from the CEO of GM. It was so close to the truth that most of us for a short time though it was the real thing. But after a few minutes of though we knew no CEO or Politician in this country would ever write a letter explaining their own stupidity. Let me write you one... I'm the head of the most powerful crime syndicate in the Country. I send my goon to the owners and trainer of Big Brown. I make it short for them, Big Brown has a future for you as a stud horse big bucks you will make. But not if he is dead. He will run dead last in the Belmont, we will make millions and you will still have your horse. The perfect sit up for the perfect crime. Just one of many that has happen so often in the stock market, in the horse racing business, the labor unions etc. A few years ago a son of Seattle Slew was expected to be a big winner in a up and coming race. He was taken out on the track the week before for a work out and fell dead on the track. His trainer an old timer in the business had these words to say. If they want to get you they will get you, and that is all he said. My final word is... the next four years if the Democratic machine gets their puppet in as President and control of congress they will perform the biggest perfect crime on the American public ever. Your going to need a lot of insider information for your business to stay ahead of these perfect crime people." – Paid-up Subscriber JR

Porter comment: I've never understood the attraction of betting on horses or boxing. I thought everyone knew these things are as "real" as professional wrestling...

"Nice reference to Galt's Gulch. Wonder how many folks will know what you're talking about." – Paid-up subscriber Jack

Porter comment: Hundreds. We got more e-mail about Galt's Gulch than just about any other topic I can remember. We were pleased.

"Now, now Dan... You know where [Galt's Gulch] is. Cafayate." – Paid-up subscriber NJP

"If you are looking for Ann Rand's Galt's Gulch, look between your ears.

If you are looking for the town she based Galt's Gulch on, go to Ouray, Colorado. – Paid-up subscriber Larry

"I find it quite incredible (and I mean it literally – in-credible) that companies like Lehman have the audacity to upgrade and downgrade other companies in light of the fact that they have proven that they can't operate their own business effectively." – Paid-up subscriber Phil

Porter comment: That's because you're assuming the men running Lehman Brothers made a mistake. They didn't...

All of these investment banks used to be private partnerships, where the partners risked their own capital. Back then, the leverage employed by the firms never exceeded 10 times. When the managers were owners, they never risked the firm. But... as soon as the owners were merely the public and the managers only had a small amount of their own capital at stake, they began to manage these firms with no regard for the risks they were taking. They simply don't care if these companies blow up. They'll go work for another firm the next day.

Once you understand it was the leverage that ruined these firms and it was the same leverage that created the millions in bonuses for the managers, it's clear why they will all fail eventually. In another 10 or 20 years, all of the investment banks will be private again because all of the public ones will have blown up.

Regards,

Porter Stansberry

Villa Reineri, Italy

June 10, 2008

Buy When Investors Panic... Make a Quick 17%

By Ian Davis

Throughout history, investors have fallen into and out of love with risk.

For example, in October 1998, investors were jumping at the chance to buy junk bonds at a measly 2.8% premium to Treasury bond yields.

Then, by October 2002, the default rate on junk bonds was spiking. To entice an investor to take on the risk of a junk bond in late 2002, corporations had to offer yields that exceeded Treasury bond yields by more than 10%.

In both cases, investment-rating companies rated the bonds similarly. So their risk of default should have been the same. Investors were just valuing the risk differently. In other words, investors become overly cautious during bear markets and overly daring during bull markets.

That's no surprise... But when investors panic, it creates inefficiencies in the market we can use to our advantage. So I wanted to figure out a way to measure exactly how serene or panicked investors are today.

My "serenity index" tracks three measures of risk: the emerging-markets spread, the high-yield spread, and the "VIX" volatility index.

Emerging-market bonds and high-yield bonds are risky assets. And how risky investors think they are is easy to quantify: It is simply their yield over a risk-free U.S. Treasury bond. The VIX, which measures the premium investors are willing to pay for portfolio insurance, is the most widely used measure of how worried investors are. Putting these three indicators together gives a fairly good picture of the market's mood.

Let's take a look at today's numbers...

The Lehman Brothers Emerging Market Bond Index is yielding only 2.8% more than 10-year U.S. Treasury bonds. This is about half of its 15-year median of 4.5%. So investors today aren't worried about risky emerging-market debt.

On the other hand, the Merrill Lynch High Yield Master II Index is yielding 6.18% more then U.S. Treasuries (way above the median spread of 4.5%). So investors today are worried about high-yield bonds.

Finally, the VIX is currently 18.4% above its historic median level. This means investors are somewhat worried about risk in the equity market.

So investors may be wary, but they're not quite panicked yet.

The following chart shows my serenity index versus the S&P 500 (I flipped the y-axis so the highs and lows line up).

Investors Are Pricing More Risk into the Market...

But They're Not Panicked Yet

The five blue lines show times when investors have panicked in the past. If you had bought an S&P 500 index fund on these panic extremes and held for just three months, you would have made an average 16.8%.

And this indicator is consistent. You would have made money every time. At worst, if you had bought in October 1987 (right after Black Monday), you would have made 10.3% in three months. And at best – if you had bought in November 2002 – you would have made 19.4% in three months.

As you can see, investors have become much less serene over the last 18 months... But they have remained relatively calm in the face of a weakening economy. When they finally do start to panic, we'll have a great opportunity for a short-term trade. If history is any guide, it will be a quick 16.8% in three months.

Good investing,

Ian Davis

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