What to think of 'the greatest business in the world' today...

Where we are in today's market...

 Where credit has gone, stocks have followed. Expanding credit means higher stock prices... and vice versa.

Take a look at the correlation between high-yield bonds and the S&P 500 for proof... When the price of bonds goes up, yield (the cost of borrowing) falls. As you can see, moves up in bond prices – as represented by the iShares iBoxx High-Yield Corporate Bond Fund (HYG) – generally correspond with rallies in the benchmark S&P 500 stock index.

 Right now, we're seeing a correction in credit. The government sold $24 billion worth of 10-year Treasurys last week at a 2.75% yield. High-yield debt fell out of bed as a result.

So far, stocks have ignored the correction in bonds. But stocks could follow as the likelihood of the Fed's tapering returns to the scene.

 Today, I (Porter) believe that we are in the very late innings of the stock market rally. The Federal Reserve cannot continue to print $85 billion a month, and every central bank in the world cannot be in competition to see who can print more money.

This is totally unstable, and it will not last. What's scary is everyone in the whole world can agree that there's no risk. They believe quantitative easing is fine and everything will be OK. But then there will be that moment when for some reason – and no one will know why – the entire attitude changes.

And then, all of a sudden, the world will abandon government bonds. It's going to abandon government paper because it's no longer reliable... because governments have warped the prices to the point where it no longer works.

We can't know when that moment will come, but we do know either that has to happen or the Fed has to stop printing. And when either one of those two things occur, yields are going to go higher. Inflation is going to return, and it will be very difficult for the stock market to maintain its current price-to-earnings ratio of 19 as bond yields ratchet higher.

– Porter Stansberry with Sean Goldsmith

Where we are in today's market...

In today's Digest Premium, Porter explains what's scaring him in today's market... and tells readers how it will all play out...

To continue reading, scroll down or click here.

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As of 11/18/2013

Please note: Securities appearing in the Top 10 are not necessarily recommended buys at current prices. The list reflects the best-performing positions currently in the model portfolio of any S&A publication. The buy date reflects when the editor recommended the investment in the listed publication, and the return shows its performance since that date. To learn if a security is still a recommended buy today, you must be a subscriber to that publication and refer to the most recent portfolio.

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Editor's note: In today's Digest, we're continuing to look back at our top writings of 2013 on the critical tools for investors evaluating stocks.

The essay – originally published in the June 28 Digest – looks at what makes "the best business in the world" so valuable for investors…

 In the June 25 Stansberry Data, Porter and his research team shared their current view on the "best business in the world" – property & casualty (P&C) insurers. We received tons of great feedback about the research. So in today's Digest, we're sharing this research with you...

But first, we'd like to explain why Porter believes so strongly in investing in these businesses…

 The best insurance companies make sure the fees they charge for capital are in excess of the risks they accept by extending insurance. Well-run insurance companies make a profit on their underwriting. They earn money by taking capital from their customers.

It's incredible. These firms compound their equity by simply opening their doors every morning. They don't have to do anything else. There's nothing else in business like it. As legendary investor Warren Buffett, whose holding company Berkshire Hathaway was built in large part on P&C investments, explained in his 2011 letter to shareholders...

In other words, these insurance companies are paid to use capital.

 Most people lump all insurance companies together. But this is a mistake. The two main types of insurance businesses are life insurance and P&C. And they're very different businesses.

The two types of insurance differ on three key variables that make up any insurance contract:

With life insurance, the "whether it will happen" variable is moot... Everybody dies at some point. The "how much" variable is also known. It's the value of the policy. The only unknown is "when"... and actuaries are good at predicting this.

On the other hand, with a P&C contract, all three of these variables are unknown. So underwriting becomes much more critical with P&C... There's a lot more leeway in the underwriting decisions P&C companies can make. With this leeway comes huge differences in underwriting profitability. Some companies have simply proven they are much better at underwriting than others...

When you add up all these factors, you'll generally find that good life insurers will enjoy steady returns, while a good P&C insurer's returns will be "lumpy." But overall returns for good P&C insurers are higher than overall returns for life insurers.

 Let's say John Doe wants to buy a life insurance policy... The life insurance company has actuaries that estimate when Mr. Doe will die. Let's say the insurance company expects Mr. Doe to die in the third quarter of 2040.

This life insurance company will perform the same due diligence on every policyholder... And it aggregates the predictions, so it has an estimate of what it will owe in death benefits in the third quarter of 2040. It's a matter of statistics. Let's say the life insurance company predicts it will need $100 million in the third quarter of 2040.

That company's investment managers will then buy fixed-income investments that will guarantee $100 million of interest payments and maturities in the third quarter of 2040. So this insurance company is locked into a long-duration bond portfolio. (And it's often further limited by what rating and type of bonds it can buy.)

 P&C insurers have much more leeway with what they can buy... For instance, Markel, a top-notch P&C firm, has about 41% of its investment portfolio in equities right now. P&C insurers can also focus on shorter-duration debt. So these firms are much better suited to handle an increase in interest rates than life insurers.

In fact, P&C insurers are hoping interest rates increase... Then they'll be able to invest their float at higher returns. Warren Buffett went on record in his 2012 letter to shareholders welcoming higher rates…

  Porter recommended a slate of P&C insurance stocks to his Investment Advisory subscribers last year. [As of November 18, those positions are up between 13% and 51%.]

So this week, Porter and his team analyzed for Stansberry Data subscribers how these positions may fare in the bear market Porter has predicted. Here's what they wrote...

 In the [June] issue of Stansberry's Investment Advisory... we noted several warning signs could be signaling the end of the world's central banks' ability to prop up asset prices with money printing ("easing") and super-low interest rates. If so, we could be entering a painful period for the global economy...

In periods of economic uncertainty, the market tends to arbitrarily sell off everything. P&C stocks could suffer from this kind of selling if interest rates start to rise – a fear if central banks rein in their current monetary policies... or if those policies stop working. As we wrote, we think this would be an overreaction...

 We have six P&C insurers in our portfolio. The average duration of the fixed-income component of these six insurers is less than four years. Even if interest rates bounced up by an entire percentage point (100 basis points, in industry parlance), we estimate that the balance sheets of our P&C companies would suffer only a 1% dip in book value. And after three to four years, these companies could roll their entire portfolio back over into bonds with higher interest rates.

This week, we analyzed how our favorite P&C companies have fared since 1990 – a period which included two significant stock market downturns...

The results are summarized in the chart below. Of our 10 higher-ranked P&C companies, eight were actively traded in 1990. If you had invested $100 into each of these companies in June 1990 and reinvested the dividends, your initial $800 investment would be worth more than $12,000 today. This equates to a 1,400% total gain, or more than 13% per year.

These are phenomenal returns, especially when compared with reinvesting dividends in the S&P 500 over this same time frame (600% total gain, or about 8% per year).

Investing in quality P&C companies may be the single best way to grow wealth over time. But you must be prepared to ride out some bumps along the way.

 To illustrate, let's go back to our hypothetical $800 investment in June 1990. By June 1998, that initial investment would have grown to more than $3,400... a return of more than 330%. However, by September 1999, your investment would have dropped back down to $2,300, a fall of more than 30% from the June 1998 highs. In fact, the eight-stock portfolio needed two years (until 2001) to recover to June 1998 levels.

A similar slump happened during the financial crisis of 2007-2008. By June 2007, the initial $800 investment would have grown to $7,900... a gain of nearly 900%. But over the next 24 months, the investments' value would have dropped to less than $5,900, a 25% loss. Of course, today, that eight-stock portfolio would have recovered all those losses... and then some.

 The point is, P&C insurers are not invulnerable to big economic headwinds. P&C stocks suffered from 1999 to 2001, when investors sold off traditional blue-chip businesses to snatch up overvalued dot-com stocks. And again, the sector slumped during the financial crisis of 2007-2008.

However, the overall trend was positive. Over the longer term, these stocks plowed higher. Patient investors recovered from temporary setbacks.

 Please note… we are not "calling the top" for our P&C insurers. We are simply urging readers to be cautious about adding to positions with the market at these levels and the macroeconomic uncertainty.

If you own these stocks, continue to hold them. And watch your trailing stops... These will protect your capital if the sector sells off too sharply.

But as the chart above shows, history is on our side. If you can ride out the corrections, P&C insurance is still "the best business in the world" for long-term investors.

 New 52-week highs (as of 11/18/2013): Automatic Data Processing (ADP), Deutsche Bank X-Trackers Harvest China Fund (ASHR), Anheuser-Busch InBev (BUD), Dominion Resources (D), iShares Germany Fund (EWG), 3M (MMM), Altria (MO), Navigators (NAVG), Constellation Brands (STZ), and ExxonMobil (XOM).

 In today's mailbag, one subscriber writes in about his inflation worries… and another is looking for gold. Send your e-mail to feedback@stansberryresearch.com.

 "My concern for 2014 is inflation. I note from prior statements in your publications that you are, as I am, suspicious of the Consumer Price Index. I remember how in the late 1970's, when mortgage interest rates peaked at 15.5%, the Commerce Department dropped the weighting on mortgage interest rates in the CPI. I don't know how they are manipulating the CPI now, but I am confident they are. I don't have the time or skill to look into this, but I think it would a worthy subject for you to write about. Of course, dropping the weighting for mortgages in 1978 was probably justified since literally no one was borrowing at 15.5%. But, it suggested to the commerce department how to handle future political issues regarding inflation. The unemployment numbers are similarly skewed. Hopefully, the Fed gets real numbers." – Paid-up subscriber Bob Cowan

 "You have mentioned your gold vendor many times but I don't remember who it was. Name and contact information please?" – Paid-up subscriber Juliana Jewell

Editor's note: We get this question from time to time… Keep in mind – we get nothing for recommending them:

Regards,

Sean Goldsmith

Singapore

November 19, 2013

Where we are in today's market...

In today's Digest Premium, Porter explains what's scaring him in today's market... and tells readers how it will all play out...

To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.

What to think of 'the greatest business in the world' today... A peek at Porter's Insurance Value Monitor...