A 100-Year Storm in Muni Bonds

Don't blow it... How to take advantage... Even the pros are scared... Buy quality, buy now... The poor Russians... Gold/oil ratio update... Should I follow my stops?... Munis melt down...

Don't blow it. Fear and panic create low stock prices, which offer patient investors unbelievable returns. Follow your stops, raise cash... but be ready to take advantage of the opportunities the market is beginning to offer investors. All year, I've been telling my subscribers this bear market would create an awesome, once-in-a-lifetime buying opportunity... And it has arrived.

We're doing several things to help you take advantage. First, as you'll see in the next few days, we've prepared a series of reports that will show you exactly how you can quickly raise more cash. The first report is about a secret way to "reset" Social Security payments at a much higher rate. If you're retired, there is a simple, easy (and yes, legal) way for you to get a lot more from the government. Look for our reports, starting this week, in The Digest.

Second, our most senior editors – Steve Sjuggerud, Dan Ferris, Jeff Clark, and I – will be hosting an hour-long conference call. We'll discuss what's happening right now in the markets. We will answer and discuss dozens of reader questions. We will talk about the emotional challenge of dealing with fear and how to identify the safest opportunities. We're putting the details together now. Look for more info in The Digest.

Third, this market is made for traders. Jeff Clark has been killing it over the last several months, making huge profits while other investors have been getting crushed. If you're not yet getting his trading advice, you're literally missing the opportunity of a lifetime. Right now, we're offering a big discount on his Short Report service. Learn more here.

The timing couldn't have been better. On Monday and Tuesday, as the markets crashed, banks failed, and governments bailed, I was lucky enough to be at the premier conference for value investors... the Value Investing Congress, which is organized by two fine people, Whitney Tilson and John Schwartz.

You'd think crashing markets would have these guys all smiling... Value investors should have been on the sidelines, since about 2004, waiting for a panic or a bear market to load up. Nope. Most of these guys were terrified. Not everyone... but most of the audience. They'd seen their portfolios cut in half. They don't have much cash. And they're probably out of a job.

Interestingly, most of the presentations focused on relatively obscure or poorly run businesses, like failed dot-coms or a land-holding company in Portugal. The market crash has come on so violently and so suddenly that most of these guys – the best securities analysts in the world – haven't yet had time to crunch the numbers on the kind of stocks they should be buying.

What should you do? Assuming you've been following your trailing stop losses, you should have a good bit of cash available.

The first thing I'd do is sit down and think of five or 10 businesses you've always wanted to own – the cream of the crop (click here to see what I'm looking at now). Perhaps for the first time in more than a decade, these businesses are available at a reasonable price.

Look to buy stocks that earn more than 10% a year on their assets, have no (or little) debt, consistently return most of their cash earnings to shareholders (via dividends or buybacks), are well respected by the public, and have simple businesses you can understand. (If you want to see my recommended stocks in this category, take a look at the "no-risk" portfolio in my newsletter.)

Second, hunt for small and microcap bargains. I've found three or four stocks recently, all selling for less than $5, that have cash balances in excess of 50% of their market caps. Wall Street ignores companies under $10 – take advantage of your edge here.

Third, profit from the huge spike in volatility, which has sent call and put premiums through the roof. Selling a covered call on gold, for example, is a very safe strategy that can provide you with income in addition to wealth protection.

I can't predict how much lower the stock market will go. No one can. But I can say I follow Warren Buffett's advice: I try to be fearful when other people are greedy, and I try to be greedy when other people are fearful.

Today, one of my analysts told me he couldn't recommend stocks anymore – not even the safest blue chips. That's fear. Meanwhile, we've gone more than 10 years without any nominal increase to the major stock indexes. In real terms (adjusted for inflation), stocks have fallen close to 50% from 10 years ago. High-quality businesses with cash-laden balance sheets are now selling for single-digit multiples and offering double-digit yields (including share buybacks). If there was a time to be afraid of buying stocks, it was in early 2007, when housing had peaked but stocks still soared.

Back then, in the February 2007 issue of my newsletter, PSIA, I advised my readers to buy puts on their long-term holdings – insurance against a market fall.

What we've seen in the market since the last bear run (2001-2002) is that almost everything has gone up. Value stocks, foreign stocks, commodity stocks, blue chips, hedge funds, insurance stocks, private-equity firms, technology, etc. Normally, you can find a sector that's been beat up for a few years. Not right now. This bull market has been the broadest four-year rally I've ever seen. Lots of investors think they're geniuses – especially the commodity guys... I think we're close to an important top in equity prices. I can't tell you how close – and it could be months and months from now. 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.

In that same issue, I recommending selling GM short and buying shares of SAP – a leading business software company – but only if its shares fell below $40. As much as I admired the business, the way the management treats shareholders, and the company's long-term prospects, it simply wasn't cheap enough to buy safely.

The stock didn't dip into my buy range. Instead it headed higher... for about six months. Subscribers were irate. But this week, SAP announced businesses were cutting back on software. In just a few days, the stock fell nearly 50%, from above $60 to around $35. You can now buy what I think is the second-best software company in the world (Microsoft being the best) for about 10 times cash profits. Ironically, the folks who were clamoring to buy it last year probably won't even look at it now.

By the way, while SAP has fallen and it is cheap... given the outlook for business spending, I will wait to buy until it has fallen below $30. If that sounds reasonable, another approach would be selling a $30 put that expires in January 2009. You could get $2.20 in premium right now. If the stock doesn't trade below $30, you keep the $2.20, free and clear. If SAP does trade below $30, you buy it. But you keep the $2.20, no matter what happens.

Don't be surprised by the market's action. The market, like teenage girls, always goes to extremes. Stocks were far too expensive in 2007 and early 2008. But the selloff we've seen since September is becoming far overdone. For long-term, wise, and patient investors, this is the time to begin putting your capital to work. Don't be paralyzed by the volatility or the bad news. Use your head. Buy quality. Get a great price. Remember: Bull markets begin in the aftermath of panics.

From David Eifrig, "Doctors are going belly-up in California because the state has frozen Medicare payments. Meanwhile, banks won't lend. So medical groups are going under because they can't pay their bills, can't get a loan, and the state won't pay them."

As the tide goes out, we're discovering lots of commodity investors were "swimming naked," especially in Russia, where the government has injected $37 billion of long-term loans into its biggest state banks. Four of Russia's largest energy companies – including Gazprom and LUKOIL – asked for state funding.

Remember, these are the same guys who have been competing to build the world's largest yachts. These are the same guys who, for the last five years, have routinely turned off Europe's gas supply. They'll be back to picking turnips soon. And it couldn't have happened to better people.

In recent issues of The Digest, we've been preaching that the mighty New York real estate market will crack. Financial-services firms rented one out of every three square feet of New York office space. With fewer banks operating in the city, commercial real estate will fall. And with fewer bankers living in the city, residential real estate demand will fall.

The amount of prime New York City office space available for rent jumped 43% in the third quarter from a year earlier. There's 18.5 million square feet for rent, up from 12.9 million a year ago. "We think asking rents are going down," one real estate expert said. "Taking rents have already gone down." (Taking rents are the rents actually paid by the renters.)

On the residential front, our dinner companion on Tuesday night recently moved to New York. He rented a five-bedroom apartment overlooking Central Park for 40% below asking price...

New highs: Not yet. But check in with us in about six months. There will be dozens.

In the mailbag, lots of very good questions. We hope our answers are useful. Send your "Need to Knows" here: feedback@stansberryresearch.com.

"Not a baseless accusation, but maybe a baseless question... You have previously shown us charts indicating that gold was cheap compared to oil. With gold now moving inversely to oil, will you, please, make the comparison again for us. It will be good to know where things stand. That said, with all the wallpaper cash flowing into the market from the central banks, and the fed threatening, er, promising to lower short terms again, it can't be anything but inflationary, right?" – Paid-up subscriber Neil A. Bourjaily

Porter comment: The key to the gold/oil ratio is the number 10. An ounce of gold ought to cost more than 10 barrels of oil. When gold is less than 10 barrels of oil, something is badly wrong. Either oil is too expensive or gold is too cheap... or both.

When oil was at $140 and gold was below $800, the ratio was absurdly low – 5.7. Extremes like this are very rare and they never last. Today the gold/oil ratio, at $900/$90, is back to around 10. We expect it will continue to trend higher. It typically peaks above 20. Assuming oil remains around $90, that gives you a $1,800 target for gold.

"I saw your comment re: BUD last night & would like to ask if you could think of any reasons that BUD would be selling at such a huge discount from the $70 buyout price." – Paid-up subscriber R. Welch

Porter comment: Nope. Horse, meet water.

"Should we ignore the standard 25% stop loss rule in a market like this?"

– Paid-up subscriber Bryan

Porter comment: Absolutely not.

We've gotten lots of questions about why certain stocks haven't "stopped out." Go back and read the original recommendations. That will answer all of your questions. Some of our recommendations use trailing stop losses, which are triggered anytime a security falls more than 25% from its peak during our holding period. Other recommendations use plain stop losses, which are only triggered if a stock falls more than 25% from its recommended price. Click here to read more.

Regards,

Porter Stansberry

Baltimore, Maryland

October 8, 2008

A 100-Year Storm in Muni Bonds

By Dr. Steve Sjuggerud

Quick, what's it cost to upgrade a sewer system in an Alabama county? How 'bout $3.2 billion...

Jefferson County Alabama is at the brink of bankruptcy. Alabama's governor just asked the U.S. government to use some of its $700 billion to save the county. The credit crisis is now hitting formerly safe municipal bonds...

Before the credit crisis, Jefferson County Alabama's net sewer revenues covered the cost of this debt. But now the debt service has essentially doubled, and Jefferson County is at the brink of bankruptcy.

Unfortunately, the two municipal-bond funds held in True Wealth actually hold Jefferson County Sewer bonds in their portfolios. These bonds weren't considered risky when the funds bought them. It was simply a big, liquid municipal bond. Those funds hold bonds with an average credit rating of AA.

While one bad performer like Jefferson County shouldn't hurt these funds' huge portfolios, we're seeing more cracks in the system... Massachusetts can't refinance, and neither can California. A crisis of confidence has now hit municipal bonds. "I spent the entire day yesterday redeeming accounts," a woman at Van Kampen told me today.

I think this is a "100-year storm" in munis. We're seeing "forced" sales into a market with no buyers, while the creditworthiness of some of the municipal bonds is being called into question. You can't know how bad things can get, so my advice is to follow your trailing stops.

Sure seems like a deal though... AAA-rated 10-year munis pay over 6% taxable-equivalent yields... and 15-year munis pay over 7% (taxable equivalent). That's way more than 10-year Treasuries at 3.7%.

Good Investing,

Steve

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