The S&A Digest: Massive Volume Marks Market Turns

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

As of 07/01/2013

Ian examines last Tuesday's decline... GM's subprime woes... How to grab a dividend... Icahn and Motorola... Blackstone eyes Chrysler... Caveman TV... It's all Porter's fault...

Don't miss Ian's essay below. Our resident quant took last Tuesday's volume and market-breadth figures apart and shows us what they mean.

What a week to go on vacation... First, the emerging markets finally rolled over, and the global credit bubble seems to be losing steam, too. Japan's yen – the favored currency to borrow – is strengthening, and America's credit dealers are collapsing. Second, inside our own little universe, more controversy erupted about our dividend-grabber strategy.

In regard to the credit bubble, emerging markets, etc., as I'd just written in the February issue of my newsletter, PSIA, stocks have been due for a correction. "I think we're close to an important top in equity prices... Bullish sentiment is now pervasive. Stocks are rallying almost every day. Everything I follow has gotten too expensive to buy safely. And investors have begun to completely ignore risk."

What do I think will happen now?

I expect emerging-market stocks to fall between 20% and 30%. Some of the more highly inflated markets (India, in particular) will probably fall more – maybe 50%. The indexes of developed countries will probably decline 15% or so. Blue-chip stocks will likely fall between 10% and 15%. One American company that's likely to get hurt badly by the decline in subprime lending is General Motors (GM). It hasn't been marked down yet, but the company's efforts to sell 51% of its huge mortgage business to Cerberus (a hedge fund) could be undone if the value of its mortgage portfolio falls far enough. GM announced last week it would delay filing its annual report because of accounting problems in its mortgage unit. A Lehman Brothers analyst predicted the subprime-lending problems would cost GM nearly $1 billion – almost 10% of its total shareholder equity.

On the other hand, assuming you've bought good companies at good prices, you've got nothing to worry about. In fact, I'm advising my subscribers to buy a very high-quality (and very cheap) emerging-market stock over the next three months, using this decline to get a great price. See my latest issue for details.

Regarding HMA's special dividend... oh boy. I want to throw my hands up. Our strategy is so simple and sound that it's nearly (note: I said nearly) foolproof. And yet... so many of you seem determined to make it complicated.

Here's what we know: When sound companies decide to return a large amount of cash to shareholders, it usually doesn't affect the value of the business. The managers aren't going to return capital if they can put it to good use. But, the market always marks down the share price the day after such a dividend has been paid by roughly the amount of the payment.

This presents investors with a great opportunity because, on these days, the stock is probably mispriced. Note: There's no guarantee the price of the stock will bounce back, but that's what our research shows is very likely to happen, and that's what common sense tells you to expect.

Obviously, if you're not interested in the dividend, buying the stock on the ex-dividend day (in HMA's case, the day after the dividend has been paid) can be very lucrative. We prefer to take the dividend and have the cash in hand, up front. Why? Because we're assuming it will take around six months for the share price to return to its pre-dividend level. During that time we can invest the cash dividend elsewhere, adding to our returns. Plus, for most investors, there will be tax advantages to taking the dividend and holding the stock for several months.

Could you do other things that are more complicated and riskier, such as buying a call option instead of buying the stock? Yes, you could. But why bother? Simply grabbing the dividend is a safe and valuable strategy.

We've been recommending "dividend grabs" in the Digest since November. Here's our track record through today:

Regarding HMA, we first brought it to your attention on January 18, 2007. On January 19, HMA shares traded between $20.68 and $19.90. There were many questions about this dividend, so we recapped our recommendation on January 30. On January 31, HMA traded between $19.52 and $19.45. Given these facts, it's safe to assume that if you followed our advice, you probably paid around $20. If that's the case, you're up a bit: Today, HMA is trading for $10.38, and it paid a $10 dividend.

While I was on vacation, a subscriber wrote to us, saying he'd been paid the dividend and was up almost 50% because the stock price didn't decline. Of course, the stock price declined immediately the next day, when it began trading ex-dividend. His confusion showed that he wasn't experienced with these situations. But what matters is whether HMA trades back above $20 within six months. My bet is, it will. Then, the reader really will have made 50%. And, even better, he would have gotten his gains in cash up front.

We'll soon launch a new publication – a special situations letter – that will take over our "dividend grabber" strategy. Hopefully, many of you will see the logic of our approach and want to subscribe.

Private-equity firm Blackstone Group is said to be moving ahead with a detailed analysis of Chrysler's failing U.S. business. Blackstone has emerged as the leading buyer, although it is said that GM is still considering a purchase of Chrysler's entire business.

Extreme Value pick Motorola (MOT) will not support Carl Icahn's bid to take a seat on the board. In its notice for the annual 2007 meeting, the company told investors not to sign any proxies sent from Icahn or his affiliates. Icahn, who owns roughly 1.6% of the company, is urging Motorola to make better use of its $11.3 billion in cash through a dividend or share buyback.

The first U.S. derivatives market for property is set to debut as early as this week. Credit Suisse, Goldman Sachs, Merrill Lynch, and Bank of America are the four banks involved in creating the platform, which has the potential to grow into a multibillion-dollar business. Property is one of the few asset classes left in the U.S. without a developed derivatives market, despite its estimated $26 trillion value.

The popular caveman commercials for GEICO insurance have been greenlighted for a half-hour pilot on ABC. The show, which has no script or cast yet, will chronicle the lives of three cavemen who face discrimination in modern-day Atlanta, Georgia. GEICO, owned by Berkshire Hathaway, will have no creative control over the program, but will receive royalty payments.

There were no new highs across our recommended portfolios on Friday.

Now that I'm back in the saddle, I expect you'll let me have it... More seriously, I'd like to know how you're weathering this correction. What steps have you taken to lighten your investments in emerging markets? In risky stocks? Tell us here: feedback@stansberryresearch.com. We read every single note, but we cannot respond individually.

"I received a $10,000 dividend on March 1, 2007 for the 1,000 shares of [HMA] stock I own. I have no intention of selling the stock, even if it takes months to go back up I will still receive a small quarterly dividend. So be patient!" – Paid-up subscriber Fran

Porter Comment: She gets it.

"Dan, Thank you for taking the helm this past week. Please don't mind Porter having the time to e-mail you what you were doing wrong. I am sure a lot of people appreciate having you for a change. Your honesty and humility are certainly refreshing!" – Paid-up subscriber Juanita

"I wanted to express my appreciation to Jeff Clark. I have been a subscriber to his S&A Short Report for only a couple of months and I have not lost money on a trade yet. Most of my returns are averaging over 100% in just a few short weeks. Jeff is the man and definitely the best I have ever seen. I can only hope he never retires!" – Paid-up subscriber Shane Mueller

"Hello Porter, Just a quick word of thanks. I believe you are responsible for saving me approximately $4,000 in lost profit by encouraging (insisting) that Emerging Market stocks were going to take a big hit. As much as I hated to I trusted your instincts and sold my EM portfolio 2 days before the bottom fell out. If you are ever in Seattle I'll spring for drinks & dinner at the Metropolitan Grill." – Paid-up subscriber Duncan DeBond

"Porter, no more holidays for you!!!!!!!!!!!!! Look what the markets did as soon as you took off. We have to blame somebody, don't we? Welcome back, by the way." – Paid-up subscriber Ken Ingham

Regards,

Porter Stansberry

Baltimore, Maryland

Massive Volume Marks Market Turns

"When the dam broke, that's when we saw the market go from down 250 to down 550 literally in a couple of seconds," said Michael Driscoll, a trader at Bear Stearns.

The computer servers that handle the Dow Jones Industrial Average data couldn't keep up with the large volume of trading that occurred last Tuesday. As the orders came flooding in, the servers began to lose ground, showing quotes that did not accurately reflect the market value of the equities being traded. When the problem was finally identified and the backup systems were brought into use, the Dow fell 300 points in a matter of seconds.

This sudden fall triggered a wave of orders that overwhelmed electronic systems during the final hour of trading.

Perhaps a larger story than the magnitude of the decline that occurred last Tuesday is the volume and breadth of that decline.

VOLUME OF SHARES BEING TRADED:

On Tuesday, the NYSE saw the 10th-highest volume of shares traded in a single day in its entire history. But, the average volume being traded on the exchange has been rising steadily since the beginning of modern financial markets (due to factors like population growth and GDP growth). Thus, relative to recent volume, the volume of trading that occurred on Tuesday was not nearly as impressive as it initially seems.

The top portion of the following chart shows the NYSE daily volume relative to the previous year's average volume. Last Tuesday's volume was only about 47% greater than last year's average.

BREADTH OF THE DECLINE:

The other unusual thing about last Tuesday was the breadth of declining stocks. The number of declining stocks was about 6.4 times greater than the number of rising stocks.

The bottom portion of the following chart shows the ratio between advancing and declining stocks on the NYSE. It is fairly rare to see such a large number of stocks declining relative to those that that are advancing.

CLUSTERED FALLS MARK TURNING POINTS:

Last week, I investigated the prior instances when the stock market declined 3% or more in a single day. Historically, these 3% declines didn't signal a turning point in the market, unless there were a number of them clustered together.

So what has happened historically when there have been large volume days with many more declining stocks than rising ones?

Similar to the situation with large one-day falls, large-volume down days seem to have much more significance if they occur in clusters. The following chart shows the previous times in history when there have been multiple large-volume down days within a month of each other.

Currently, we have only seen one of these situations within the last month, but with the way the global markets are acting, I wouldn't be surprised if we saw another sometime in the near future.

Conclusion:

We could be near a turning point in the market. Whether this turning point turns out to be the beginning of a serious bear market or only a modest correction in an ongoing bull market is yet to be seen. However, I believe it would be prudent to err on the side of caution during the next few months.

Good investing,

Ian Davis

March 5, 2007

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame