What's next?

What's next?... What's safe to buy now?... Blue chips... PSIA portfolio update... The curse of the tallest building... Sovereign wealth disasters... Another zero... Bad arithmetic...

Jeremy Grantham, who manages about $150 billion as chairman of Boston's Grantham, Mayo, Van Otterloo, had been predicting a collapse in the market for several years. Going back to 2006, he predicted at least one major bank would fail. He's an expert at value investing and one of the most experienced and successful investors of the last 30 years. He told Barron's this weekend he expects it will take a while for the market to bottom:

Great bubbles, like the one in 2000, take a long time to wash through the system, and you shouldn't really expect a low much before 2010. The fair value on the S&P is about 1025... This was not only a monetary event, but it coincided with the first truly global bubble in all assets. You had inflated housing in almost every country in the world, except for Japan and Germany. You had overpriced stocks in every country in the world. And you had too much money and too-low interest rates. I was confident about very little, but I was confident that this would be different from anything we had seen before, and potentially more dangerous...

What does Grantham say he's been doing with his clients' money? Something that will sound very familiar to readers of my newsletter, PSIA.

In a nutshell, we are as conservative as we can possibly get. One bet that has been very successful for us, touch wood, has been long high-quality, blue-chip stocks, particularly in the U.S., and short risky companies. We have been screaming against risk-taking for a long time, and in recent weeks, it has paid off enormously.

I sent a portfolio update to all PSIA subscribers this afternoon. It's posted on the website too, if you haven't seen it yet. Since 2006, I've been beating the same drum, month after month: Blue-chip stocks are the only cheap assets left in the world, and you can own them safely.

So... how did our recommended portfolio handle the complete washout of the stock markets last week? We didn't lose any of our "no risk," blue-chip stocks. By selling calls against our positions most of the year, we've generated lots of income to cushion against the volatility. Now, for the first time ever, our entire portfolio is rated "buy." As stock prices recover, the income we've booked from selling calls will add significantly to our total return.

One more note about PSIA's performance: In the midst of today's awesome rally, one stock did fall significantly – our most recent short-sell recommendation. (Hint: It's a newspaper publisher.)

Like Grantham, as we've been buying top-quality, blue-chip stocks, we've also been selling the riskiest, poorest-run companies we can find (and they're lots of them). You've seen us point out General Motors, Freddie Mac, and Fannie Mae. This newspaper publisher will be next. Things are so bad in the newspaper business, several newspapers are cutting Monday editions. Print advertising fell a record 16% in the second quarter. The third quarter will be even worse. As revenues fall, costs continue to rise: Paper is up a record 35% in the past year. The company we're shorting has been on a three-year acquisition spree. It is loaded with debt and a bunch of terrible assets it overpaid to acquire. It's going to zero. You should know by now that I'm not kidding. To learn more about PSIA, click here...

Taking a cue from the U.S.'s $700 billion financial bailout, world governments are jumping in to save their banking systems. Norway offered to swap up to $55.4 billion in government bonds for commercial banks' mortgage debt. France will provide up to $491 billion to shore up banks, and Spain will back up to $135 billion in bank bond issuances. Royal Bank of Scotland, HBOS, and Lloyds TSB will receive a $64 billion bailout from the U.K. government in return for ceding majority control.

All over the world, the printing presses are being turned on, lubed up, and set to "high." We feel better and better about the gold bullion we've squirreled away.

It's one of the most obvious pieces of financial advice you'll ever receive: Never invest in the country building the world's tallest building. Dubai, home to the Burj Dubai (the newly completed world's tallest building), is in trouble. Government-controlled companies in the oil-rich nation owe at least $47 billion, more than Dubai's gross domestic product. Dubai is looking to Abu Dhabi and the United Arab Emirates for support. You'll recall the Empire State Building was completed in New York in 1930. The World Trade Center and the Sears Tower were both completed in 1973. The Petronas Twin Towers in Malaysia were completed in 1998, just in time for the Asian crisis. Taipei 101 (in Taiwan) looked like it might finally break the curse. Taiwan's market has rallied since it opened in 2004... until very recently. But the curse of the tallest building finally caught up with it...

Dubai's other big problem, besides being massively overbuilt, is a horrible investment portfolio. You'll remember how everyone was worried in 2007 and early 2008 about sovereign wealth funds. Middle Eastern and Asian governments would soon buy everything in America and control us. Remember? Ha, ha, ha...

Governments are the world's worst investors. State-owned Dubai World last year paid $5.1 billion for almost 10% of Kirk Kerkorian's casino resort operator, MGM Mirage. Since then, the price has tumbled to $16.80 from $84. Another Dubai government firm, DP World, bought port and shipping giant Peninsular and Oriental Steam Navigation Co. in 2006 for $6.8 billion. Its shares have slumped 55%. The U.S. wouldn't allow DP World to buy the Port of Long Beach. Too bad. We could have bought it back for pennies on the dollar today...

We've already seen numerous small hedge funds close shop, but last week's market action crushed even the biggest players. Jeffrey Gendell's $10 billion Tontine Associates hedge fund is down 65% year-to-date. Gendell wrote to investors that Tontine "cannot make that money back overnight," but he'll allow "investors to add to their funds and keep their remaining lock-up periods." One executive at the fund told the New York Post that Tontine is meeting all margin calls, making redemptions, and not unwinding the funds. Gendell is a large investor in U.S. Steel, engineering firm KBR, and railcar manufacturer Trinity Industries.

New highs: Nope. Not yet...

In the mailbag, we're all going to hell. And I get beat up for ridiculously bad arithmetic. Send your criticisms here: feedback@stansberryresearch.com.

"Amazing how prophetic it is now: Ayn Rand in Atlas Shrugged: 'Watch money,' she said. 'Money is the barometer of a society's virtue. When you see that trading is done not by consent, but by compulsion – when you see that in order to produce, you need to obtain permission from men who produce nothing – when you see that money is flowing to those who deal not in goods, but in favors – when you see that men get rich more easily by graft than by work, and your laws no longer protect you against them, but protect them against you – when you see corruption being rewarded and honesty becoming a self-sacrifice – you may know that your society is doomed.'" – Paid-up subscriber Kurt Zanelotti

Porter comment: Well... I can't argue things aren't trending that way, but I don't think America is going to hell quite as fast as the stock market does. We will survive. It just might take a bit of pain before the average man decides he can't trust OBAMA! any more than his used car salesman...

"'[I]f you'll agree to buy Bank of America at $15.... since you've already been paid $2.90 for agreeing to buy it, your real capital cost will only be $13.10.' Selling puts is a sophisticated and schrewd tactical approach to this market. That is why I pay real money for your advice, and try to ignore your math skills!" – Paid-up subscriber Tom

Porter comment: Yes... clearly I botched that bit of arithmetic. You'll have to cut me some slack, though. Prices were moving so fast at the time I was writing that report, I had to do all the calculations about five different times. Obviously, I missed updating part of that sentence. I made another mistake that's far more important... In the Put Strategy Report, I wrote... Microsoft offered to pay $22 for Yahoo. I was way off. They actually offered to pay $33. That should give you some indication of why I believe selling puts on Yahoo is "free" money. Horse, meet water.

Regards,

Porter Stansberry

Baltimore, Maryland

October 13, 2008

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