Sjug sent us an interesting note this morning:
Virtual banks are still the place to be... [My latest virtual bank recommendation] reported today: interest spread of 2.05%, dividend of $1.00 (a 17% dividend at current share price), company completed a $200+ million capital raising in December. Spread should widen this quarter, year-end earning 5.28% on 100% govt-backed mortgage paper. Cost of money probably less than 3% so far in '09. Analysts estimate this year's earnings will increase every quarter, for a $4.77 full year number.
If [this virtual bank] "only" pays out $4.50, that's a 19% yield in 2009. If it earns and pays out all $4.77, that's a 20% yield. All that, for less than 1.2x book...
If you don't know about virtual banks yet, you owe it to yourself to find out all about them. They're the perfect investment vehicles for the current environment. I recommended one last November in my newsletter (PSIA). It was a $14 stock at the time and paid a $0.50 dividend in December. It should produce at least another $2.20 in income this year. That's an 18% dividend on an almost risk-free asset. Sjug covered his recommended virtual bank in the October 2008 issue of True Wealth.
What's behind the mortgage crisis? Simple... a bunch of people assumed obligations they couldn't possibly afford. Says the Wall Street Journal:
Data released in December show that more than 40% of borrowers were at least 60 days past due eight months after their loan was modified... many troubled borrowers have home-equity loans or credit-card debt, auto loans or other obligations that make it difficult to afford even a lower mortgage payment.
No amount of "restructuring" and no amount of "stimulus" is going to change the fact that a large percentage of Americans were fools and borrowed far more money than they can ever hope to repay. That's why we have bankruptcy and foreclosure laws. We don't need a bailout. We just need the government to get out of the way. The fools would learn a hard lesson about saving and spending – but life would go on. The banks that made subprime loans, "liar loans," and second mortgages would get wiped out. Their shareholders will be wiped out – and have been already, actually.
That's the nature of capitalism – there are winners and losers. But the benefit of this process (assuming the government would simply get out of the way) would be much, much lower asset prices. For people who have saved, waiting for the day they could afford their first home or a vacation home, this should be the moment they've been waiting for. But the market can't reach a bottom, and the recovery won't begin as long as the government keeps promising to put Humpty Dumpty back together again.
For example, Bond King Bill Gross, manager of the world's largest bond fund, is loading up on mortgage-backed bonds. Why? Does he really believe mortgage defaults have peaked? Not at all.
Gross says his current investment strategy is to front-run the U.S. government. He believes a large chunk of Treasury Secretary Geithner's $2 trillion bailout will be used to buy mortgage debt. So as of the end of January, Gross put 83% of his $136 billion Total Return Fund in mortgage debt. Is this the most efficient way to allocate capital? Is this the best way to run the economy, by trying to front-run the government? No. But that's the game on Wall Street for now, and it will be as long as the government keeps trying to re-inflate the credit bubble.
We've been wondering how long our government's foreign creditors would put up with the U.S. Treasury's nonsense.
My bet for the biggest surprise of 2009? Foreigners stop buying our debt and long-term interest rates in the U.S. soar. Think it can't happen? Think it won't? Well, it shouldn't happen (but it will). Foreign governments should buy our bonds like there's no tomorrow to help force down the value of their own currencies. But what if they don't have the money?
– January 23, 2009, S&A Digest
Today, news came out that China's exports plunged 17.5% in January from a year ago. Imports dropped 43%. The economy is still worsening. And a former adviser to the Chinese central bank, Yu Yongding, today announced China should seek guarantees that its Treasury holdings won't be eroded by "reckless policies." He added, the U.S. "should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way."
Just when you thought the New York Times couldn't possibly publish anyone more... ah... entertaining than Thomas Friedman, they've decided to publish Michael Kinsley's "analysis" of the newspaper industry:
Newspaper readers have never paid for the content (words and photos). What they have paid for is the paper that content is printed on. A week of The Washington Post weighs about eight pounds and costs $1.81 for new subscribers, home-delivered. With newsprint (that's the paper, not the ink) costing around $750 a metric ton, or 34 cents a pound, Post subscribers are getting almost a dollar's worth of paper free every week – not to mention the ink, the delivery, etc... A more promising idea is the opposite: give away the content without the paper. In theory, a reader who stops paying for the physical paper but continues to read the content online is doing the publisher a favor.
Kinsley's ideas are what ruined the entire newspaper industry. The only healthy newspaper in America is the Wall Street Journal, which, by the way, was the only major paper to never offer its content for free online. In fact, the Wall Street Journal even charges its print subscribers to access the newspaper via the web. People will pay for content – when it's useful and when they can't get it for free. Paper has nothing to do with it.
New highs: Our short sale of Capital One (COF).
In the mailbag... The collapse of Social Security, followed by one of
the best notes we've ever received. Think you've got something better to say? Send it here: feedback@stansberryresearch.com.
"As I understand it; most Americans believe they pay their monthly social security payments into a fund that is held and invested by SSA until they retire. Then SSA pays them from those proceeds. We are informed that social security is not a tax, it is insurance. I am told that in reality, SSA takes your payment and doles most of it out immediately to the present social security recipients. Can you please explain what the difference is between this behavior and Madoff's except for the fact that social security payers are required to participate (and could actually go to jail in extreme case for non participation) whereas Madoff's 'victims' had a choice whether or not to get involved?" – Paid-up subscriber PB
Porter comment: No, I can't. Social Security is merely a government-organized Ponzi scheme. And sooner or later, like all such schemes, it will collapse. My bet is the collapse will happen slowly, so as not to rile the electorate. First, they'll move up the age at which benefits begin to accrue – to 70 or 75. Second, they'll stop adjusting payments for inflation or use a phony inflation number to make the adjustments. And third, they'll begin to apply "means testing" to the benefits, which means anyone who actually contributed greatly will get nothing back, because they're already "rich." Welcome to Amerika, comrade. From each according to his means, to each according to his needs.
"I have found Porter Stansberry's Put Strategy Report to be enlightening... it may be the best strategy I have come across to generate income and recoup losses... I am grateful to have been introduced to, and educated about, such a great trading strategy." – Paid-up subscriber John Riley
Porter comment: Thanks! Are you sure we're not related?
"Your explanation of Mr Madoff's scheme was the clearest I've seen, and I think I can offer insight into his inspiration: The most popular bar in Alaska is a rowdy big place in Anchorage called Chilkoot Charlie's. It's been there since 1970, before the oil boom. Their motto is emblazoned on the back of their shirts: 'WE CHEAT THE OTHER GUY AND PASS THE SAVINGS ON TO YOU.' Think old Bernie might have taken a trip to Anchorage sometime in the last 35 years?" – Paid-up subscriber Russ Ringsak
"I wanted to add my two cents into the Madoff scam explanation. You wrote that 'investors often get what they deserve, which is only rarely what they expect.' And you are so right. I always felt the single most cause for investors pain is unrealistic expectations. Investing/finance is the only field in the world where everyone is a genius. At parties, I don't even tell people what I do. I tell them I'm a bricklayer. If I mention I'm in finance, guaranteed, within 45 seconds they're telling me what I should buy or sell. Ever meet a brain surgeon and then assume you know more than him about brain surgery? Only in finance. Nope, when I'm socializing I'm a bricklayer. But here's one thing this bricklayer knows. Unrealistic expectations will blow you up. So what's realistic. A quick, easy metric to use is called a MAR Ratio or Managed Accounts Reports Ratio. It is simply the average compounded re turn divided by the one time worst drawdown. Translated into, the price you must pay to earn those returns in a specific strategy. So what's a good MAR ratio. Buffett, Dennis, Eckhardt, Neff, Dolphin, Saxon; all 'Hall of Fame' managers have a Mar ratio less than 1/2. So if you're shooting for a 20% return per year, well you can absolutely count on at least 40% drawdown – but only if you're as good as the above list. You need a good five years or so to get a ratio that means anything. The law of large numbers always results in some clown making 60% returns for a year or two only to get blown up the next. The only exception I noticed is option writing strategies. They can produce Mar ratio's of many multiples for 5–6 years, but then they usually blow up. To make money in those types of strategies you really have to toe the line, and eventually, well, you fall over it. So if you see some extraordinary returns with little or no risk, well, maybe you found someone with the Midas touch, but then again maybe it's just fools gold. Caveat emptor! Keep up the good work." – Paid-up subscriber Nick Pingitore
Porter comment: This is one of the best notes we've ever gotten. Thanks for your insight and your wisdom. The MAR ratio analysis should be taught in every high school in America. Of course, as long as you know there's no such thing as a free lunch, you pretty much understand the concept. But you know what old P.T. Barnum said: "No one ever went broke underestimating the intelligence of the American people."
Regards,
Porter Stansberry
Baltimore, Maryland
February 11, 2009