What's this Digest all about?...
What's this Digest all about?... Congrats (and thanks) to Doc and Dan... Telling you what I'd want to know, if our roles were reversed... Why indexing is a fraud...
Yes, I know it's already January 6. But this is my first Friday Digest of the new year, so please allow me to wish you a "Happy New Year" and review a few basics for any readers who are new to Stansberry & Associates Investment Research...
This e-letter – the S&A Digest – is written by three Stansberry & Associates editors – yours truly (Porter Stansberry), Dan Ferris, and Sean Goldsmith. It says "from the desk of Porter Stansberry" because my office organizes these comments, reviews them, and publishes them.
The scope and purpose of the Digest is pretty simple. We're sending you the latest news and the context of that news, as it applies to the themes we are currently following in our newsletters. For example, you've been reading in the Digest about the ongoing sovereign debt crisis, which is part of our larger End of America theme. You've also been reading about the large onshore oil and gas discoveries in the U.S., thanks to the latest shale production technology. And you've been reading about what we call "World Dominators" – cheap, high-yielding, blue-chip stocks that we think will do well, given the current global macro situation.
The Digest, as you might have noticed, is free. We don't charge you anything to receive it. It comes with any subscription you buy from S&A Investment Research. In addition to sending you the Digest, we send e-mails that offer other newsletters for sale (almost all of which are published by us). If you don't wish to receive these offers, you can always cancel the Digest by simply following the instructions we include with each copy. (See below.) We hope you'll stick with us, though, because most of our subscribers tell us the Digest is the most valuable thing we publish.
On Fridays, I write the Digest personally. And I cover different topics from the ones you see Monday through Thursday. On Fridays, I try to pull back the veil on how our business operates and how finance works in general. As I'm sure you realize, the financial industry doesn't exist to help you get rich. It's the other way around. Likewise, frankly, with the financial newsletter business.
Most of the advice you're likely to get from mainstream financial service providers is simply wrong and designed to enrich the providers of the services. Similarly, most newsletter publishers couldn't care less about the quality of the advice they're offering – they only care if it sells.
But on Fridays, I turn the tables on the way these businesses normally operate by simply telling you what I would want to know if our positions were reversed.
In the past, I've written about the importance of valuation and asset allocation. These are the two real secrets to investing – and yet few people ever discuss them in detail. I've also written extensively about the exceptional risk-to-reward properties of corporate bonds trading at a discount to face value. I would bet a lot of money your broker will never explain how this situation works. You should also review my writing about selling options (rather than buying them, as most individual investors do). Today, I'm going to take on the mutual fund industry's most sacred cow – "indexing."
But first...
I'd like to congratulate Dr. David Eifrig on what I think was one of the best calls made last year. "Doc," as we call him, has been a skeptic of my End of America scenario. Instead of fleeing the municipal bond market last year, he heralded the opportunity he saw in muni bonds, telling his readers to buy. The fund he recommended in his Retirement Millionaire service rose 20% last year. That was one of the best, low-risk ways to make money last year.
I'd also like to congratulate Dan Ferris. Since the end of 2009, Dan has been warning us that the macro environment would probably lead to a "flat" market, in which stocks would fluctuate up and down without actually going anywhere for several years. In such a situation, investors who focus on dividend-paying stocks would outperform the market by a wide margin.
In 2011, eight of the 10 high dividend-paying stocks he was recommending in his 12% Letter advanced. Only one stock (Becton-Dickinson) was down by much (11%). The others did extremely well compared to the flat S&P 500. McDonald's was up 30.1%… Altria was up 21%... Abbott Labs was up 17.5%... Intel was up 16.4%…
I could go on… But the point is, Dan was right about the market conditions and which stocks to buy in 2011. Congratulations, Dan. You've done a great job for our subscribers.
Longtime readers know that unlike every other newsletter publisher we know of anywhere in the world, we produce annual "Report Cards" that show you exactly how all of our products have performed. Poor-performing products (and analysts) are discussed... and dealt with appropriately. Most important, as you'll see, our analysis incorporates both the total average returns of the advice we offered and how many winners versus losers were recommended. That tells you a lot about whether or not the advice is risky... or safe and accurate.
We continue to call on all newsletter writers to follow our lead in this "total transparency." But after nearly a decade of annual Report Cards... so far, none of our peers has followed our lead. Maybe that's because they can't. Regardless, we are compiling the data and will publish our annual Report Card soon.
Now... about those index funds... Many people in the mainstream financial world like to hide behind the public's acceptance of so-called "indexing." Indexing means buying the stocks in the Standard & Poor's (S&P) 500 Index, holding them, and buying more on a regular basis. Sometimes, you buy at the right time. Sometimes, you buy at the wrong time. But over many years, you'll get a good return... or at least, that's the assumption.
Of course... that's not what actually happens for most people, as I'll explain. But before I tell you why indexing doesn't actually work for most people, I want you to understand why it's so popular with financial institutions.
Indexing takes all of the responsibility for your investment performance out of the hands of financial institutions. If your investment account doesn't do well, it's not your brokerage's fault – it's the economy or the stock market that caused the problem. Meanwhile, indexing requires that you stay with a firm like Vanguard (the leading index firm) for a long, long time. These firms get your fees for decades whether or not your account grows. And to make sure that there's never a bad time for you to send them your money, they sponsor all kinds of academic research that "proves" you can't time the market, which is another way of saying value doesn't matter.
It's complete nonsense. Clearly, some times are better than others to buy stocks. Isn't it obvious that in 1982 – when you could have bought the Standard & Poor's (S&P) 500 for less than eight times earnings(!) – your future returns were going to be better than buying the index in 2000 at close to 50 times earnings? Yes. That's why all the good research on the topic shows that the price you pay for stocks – the valuation – is the ultimate determinate factor in your future returns.
Just look over the last decade. Imagine that on the first day of the year every year since 2002, you put $10,000 into stocks, corporate bonds, or gold. You would have made 23% – total return – in stocks. You would have made 44% in corporate bonds. And you would have made 190% in gold.
Why? Ten years ago, stocks were very expensive relative to earnings… and gold was only beginning to emerge from a 22-year bear market. But indexers would tell you there's never a bad time to buy stocks. It's hogwash.
And here's the final nail... have you ever considered how these index funds actually work? Almost all of them are based on the S&P 500. This is simply a list of the 500 largest American companies that trade freely on our stock exchanges. That makes some sense – you want to own the leading companies, assuming you can buy them at a reasonable price.
But here's the incredibly stupid part. S&P organizes its index by giving the biggest, most expensive stocks more "weight" in the index. Thus, the companies least likely to perform well for investors (because they are already big and expensive) end up collecting the largest amount of investment capital from index funds. Said another way, index funds guarantee your money will mostly go into stocks that are a lock to do poorly relative to other smaller and cheaper companies.
Does that make any sense? If you think it does, I'd love to hear your argument. Send it to me at feedback@stansberryresearch.com.
What do I suggest you do with your investment capital? Simple: Allocate to value. I see tremendous value today in real estate, where I'm buying cheap apartments with gross yields (before expenses and taxes) in excess of 20%.
Likewise, I see value in gold mining shares and certain areas of the oilfield-services complex. When you can't find value in stocks or bonds or real estate, don't be afraid to simply sit on cash (and high-quality bonds) and wait. The institutions don't ever want you to be out of the stock market because they don't get paid when you hold cash. But there are plenty of times when it will pay off – for you – to be out of stocks.
New 52-week highs (as of 1/5/12): Keyera Corp. (KEY.TO), Pretium Resources (PVG.TO), Enterprise Products (EPD).
In the mailbag... some arguments I find sadly typical of many of my fellow Americans. I read all of your comments... even the ones that make me think there's no real hope for our country's future. Send them to feedback@stansberryresearch.com.
"I started listening to your rants in the hope that you could point me to investments that could help me survive the chaos. You've done poorly in that respect, although some of your advisors, like Dan Ferris, do have valuable contributions to make. But I see just as much chaos in your advisors – who are all over the map – as I do in the rest of the financial world.
"Stick to investments. When you rant, you're just another disgruntled voter desperate to show the world how angry and ignorant you are. Your widely advertised ignorance – such as the absurd remark about solar energy violating the second law of themodynamics – debases your currency... I'm starting to see that the likelihood of the disasters you fear is declining, as world leaders take the possibilities into account and make appropriate adjustments. Are you as open minded as flexible as they are? I have my doubts, but I also have my hopes." – Paid-up subscriber Dale Napier
Porter comment: Dale, you've got it exactly backwards. I've long explained that solar energy will never overcome the serious physical limitations of the Second Law of Thermodynamics. And as a result, it will never be a suitable or remotely economic means of generating on-grid electricity. That is, solar energy – as currently conceived by all of the publicly traded stocks and the current administration – is simply a pipe dream that's doomed to failure.
Likewise, what in the last 100 years of history gives you any hope in the leadership of the world's great powers? By my study, their "open mindedness and flexibility" has caused disaster after disaster. Their latest efforts will surely prove no different.
"Your December newsletter was a great read and made two important points: 1) the problems facing America are moral – the 'get yours' culture – and 2) the corruption this entails is bipartisan. The Tea Party and the Occupy movement both see different aspects of this and appear different – but they are both responding to the underlying issues you identify.
"While the article was important it also has some mistakes... [A] correction is warranted when you write that Democrats 'have created an entire subculture of people who live and trade in various forms of welfare. If you don't believe me, spend a few days shopping in your nearest ghetto. Look for the "Use EBT Here" and "We Accept WIC" signs... '
"First of all, Republican senator and vice presidential candidate Bob Dole was a big supporter of food stamps (the 'EBT' in your quote) and WIC; he (and other Republicans) joined with liberal Democrat George McGovern to lower eligibility requirements for food stamps, something strongly supported by Kansas farmers.
"Second, to make your point that there is a subculture that lives and trades in welfare, you give your readers the impression that it is a large component of the government's nutrition assistance programs. It's not. Food stamp trafficking – selling food stamp benefits for cash at a discount – is a direct expression of living and trading in welfare. I created the methodology by which the government measures the amount of food stamp trafficking (see here).
"And yes, in the places you label 'ghetto' (as well as in many other areas), around 12%-15% of small 'mom and pop' food stores engage in trafficking. However, very few food stamp benefits are redeemed in these stores. The vast majority of food stamp benefits are spent in supermarkets where trafficking is essentially zero.
"Overall about 4 cents of every food stamp dollar is trafficked – this is not 'an entire subculture.' Moreover, food stamp participants tend to enter and leave the program: about half of new participants stay on the program for 10 months or less. The subculture you talk about exists, but it is a small part of the population that receives food stamps.
"The truth, at least as I see it, is that some government assistance creates dependency but some government assistance helps people get back on their feet and return to a productive life. It is not all black or white.
"What I hope is that your essay gets people to recognize that the problems are on both sides of the aisle. The gridlock of our political system comes from the fact that neither side can own up to its own faults, nor can either side admit that there is truth to what their opponents say. The Occupiers seem to think that 'the 1%' is composed only of people like Steve Ratner and the Regas brothers. In reality, the problem is corruption, not inequality. Many of the 1% worked hard and honestly and deserve to be there. House Republicans seem to think that taxes should always be cut and never raised. But Ronald Reagan supported tax increases to control deficits. Political gridlock is the ultimate expression of a "get yours" culture. I hope your essay sparks a dialogue that gets past gridlock." – Paid-up subscriber Ted Macaluso
Porter comment: I won't bother arguing with you about whether or not Republicans or Democrats are more responsible for the gross excess of our welfare programs. In my mind, all you have to do is look to see who the recipients vote for... and the answer is, overwhelmingly, Democrats. If they're not mostly responsible, there's a strange disconnect between cause and effect, wouldn't you say?
Regards,
Porter Stansberry
Miami Beach, Florida
January 6, 2012