"Everything is cheap"

"Everything is cheap"... Don't abandon stocks... John buying mortgages Hank doesn't want... Another founder ouster... Klarman buying debt ...

Oaktree Capital's Howard Marks told Barron's recently, "Everything is cheap. The question is: What is the cheapest and what do you feel more comfortable with?"

Marks is well-known for simple but insightful commentary. He also told Barron's, "Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep, on average. It is not sufficient to get through on average. You have to get through every day."

For leveraged players, Marks raises an excellent point. If you're right on average, you can still blow up and lose everything. But for unleveraged, outside, passive minority shareholders in publicly traded equities, the opposite applies. The latter must remain focused on the long term and accept that it's virtually impossible to avoid times when your account will be down 20%, 30%, possibly even 50% or more over a lifetime of investing in stocks. All the people who are abandoning stocks forever because the market crashed this year do so at great risk of never making any decent money as investors.

Investors beware. The grisly scene in the rearview mirror is seductively crystal clear, tugging at your gaze, as though you'd just come upon a head-on collision, smoke pouring out of crumpled hoods, the spray of shattered glass, black skid marks staining the highway, bodies bent like discarded dolls... You're horrified, and yet you can't take your eyes off it.

That's what stocks look like to most investors right now – and they couldn't be more wrong.

It's the foggy, darkly lit, constantly out-of-focus view ahead that investors should scan. The view is opaque, but you can make out some vaguely familiar markers – like staring at yourself in a funhouse mirror through your half-blind uncle's Coke-bottle glasses.

It may feel like a strain... but looking at your future won't destroy your vision. It'll strengthen it. You don't have to know how all U.S. consumers will fare next month and next year to know that Coca-Cola at roughly 13 times pretax earnings – a dirt-cheap price for one of the world's great cash-gushing franchises – is a great investment.

That's the view you need to keep your eyes on. That's where tomorrow is. And that's where all fortunes from this moment on will be made and lost, including yours... if you're smart and courageous enough to stay in the game. Don't abandon stocks, not when they're this cheap. Tomorrow's successful investors are building the foundations of great fortunes right now. Be one of them.

In the current issue of Extreme Value, I've found a great stock that will benefit handsomely from the fallout that's begun to hit the credit-card industry. I've known the company since it went public in November 2002. It's a great business, run by frugal, caring people. The three founders share an office, and executives get no perks that aren't available for all employees. It's cheaper than it has ever been, selling for less than half what any rational private buyer would pay for it. Click here for more details on Extreme Value.

John Paulson, the hedge-fund manager who personally made $3.7 billion shorting mortgage securities last year, is now taking the other side of the bet. Paulson started buying troubled mortgage-backed securities at the end of last week, following a decline in value after Treasury Secretary Hank Paulson decided not to use his $700 billion to buy toxic assets. In his third-quarter letter to investors, John Paulson said his strategy was "to reduce leverage, maintain market exposure and maintain short credit bias." He wrote, "The majority of our gains came from short positions in the equities of declining financials and CDS [credit default swaps] on financials. Generally our short exposure has been reduced as many of the companies we were short have failed."

In his third-quarter letter to investors, Seth Klarman of the Baupost Group wrote, "Today, there are prices that discount complete disaster, where investors are being extremely well compensated for providing liquidity to those who have become desperate. The only difficulty is in not knowing how low prices may go, how much pain you must be prepared to incur before you reap exceptionally likely and considerable gain."

Klarman said he's taking advantage of this time to add to his position in distressed debt. But he's avoiding bank debt at the operating company and holding company levels because it is subordinated to the claims of a bank's depositors and "therefore subject to a complete wipeout in the event of a failure."

He also sees opportunities arising in corporate debt, "especially in the debt of companies owned by private equity firms through leveraged buyouts," so-called leveraged loans.

Throughout his letter, Klarman told investors this crisis wasn't difficult to spot. Banks were leveraged 30-to-1, and even small errors could mean disaster. He said his firm was continually approached by Wall Street about exotic derivative products they couldn't understand without "great strain," so they said "no thanks."

"Most of today's troubles could have been avoided if more people had the sense to just hang up the phone," he wrote.

Jerry Yang co-founded Yahoo, then became its CEO in an effort to try to turn the company around. Now he's out as CEO. The Jerry Yang story is a familiar one among iconic tech companies. Founder creates business that blows away everyone's expectations. Founder turns out to be not such a great CEO. New management takes over. Founder comes back.

From there, the scenario plays out differently from company to company. Gateway is gone. Dell continues to struggle. Apple is as weird as ever... Its co-founder, CEO Steve Jobs, appears at times to be wasting away in inverse proportion to his still-innovative company's incessant growth. It seems a normal part of corporate life for a business to outgrow its founder. What happens after that is anybody's guess.

Ben Bernanke and Hank Paulson are defending themselves before a congressional committee as I write this, testifying on the bailout plan. Ron Paul said the world's central banks own 15% of all the gold ever mined. He said the dollar is dead and asked the Fed chairman if the subject of a new reserve currency standard ever comes up in meetings he attends. Bernanke said no. Paul then asked if the subject of gold ever comes up. Bernanke said it only comes up when the plans for central banks to sell gold are discussed.

Have you noticed that when the economy appears normal enough to lie about, the government tries to enforce myriad banking rules designed to prevent banks from consolidating power? But... when the economy appears dysfunctional enough that lying about it gets harder, all of a sudden consolidation of the banking sector becomes the government's No. 1 priority.

Normally, you're not allowed to own more than 10% of the country's deposits. But watch, Countrywide fails and hey, it's OK for Bank of America to buy it, blowing right through the deposit limit. Bear Stearns fails, and the Fed puts $30 billion behind its acquisition by JPMorgan. Merrill Lynch fails, and in rides Bank of America again. WaMu fails, and the FDIC can't shove it at JPMorgan fast enough, since WaMu's $182 billion in deposits totaled four times the FDIC's reserve. Then the Treasury pours new capital into the banking system, and the first word on everybody's tongue is acquisition.

I have to wonder... if banks need to consolidate to become strong enough to avoid failure, could they have avoided failure to begin with if there weren't rules designed to prevent "too much" consolidation? Is it possible the market is a better regulator than the government?

BlackRock, the largest publicly traded U.S. asset manager, is the latest firm to announce job cuts – the first cuts in its 20-year history. The company sent a memo to its 5,500 employees yesterday, though it did not say how many would lose their jobs. Notices will be issued this week. "Times like these require fiscal discipline," the unsigned memo said. "We expect it of the companies in which we invest and we must expect it of ourselves."

For a few weeks or so I've been saying stock market bottoms don't feel this good. Yesterday Porter says he doesn't feel very good, and many people will never buy stocks again after 2008, implying that the big stock indexes have hit bottom.

I'm still skeptical, though I do admit that various signs of ultimate distress are appearing. I got a good sign by e-mail yesterday. One of our talented copywriters proposed that, to sell my newsletter, Extreme Value, he'd write a story that entirely avoided the subject of stocks. In other words, stocks are more attractive than they've been in decades, and nobody wants to hear about them.

Our copywriters are very good. They'd make advertising pioneers Claude Hopkins and David Ogilvy proud with their ability to figure out what our customers want. When our guys tell me the big idea they've got right now is to avoid all mention of publicly traded securities, I know it's time to buy publicly traded securities.

Another sign of a possible bottom: I wasn't able to confirm it, but I heard yesterday that U.S. large-cap stocks haven't produced negative 10-year returns since before the Civil War.

With that, I'm definitely starting to feel a little of Porter's pain. A number of folks thought the October 10 low of 839 on the S&P 500 was the bottom. The S&P then dipped to 818 last Thursday. But one thing causes me to remain skeptical: the overwhelming dearth of patience in market participants. Patience is the supreme virtue that investors need and the one they all seem to lack.

New highs: Anheuser-Busch (BUD), short sale of Gannett (GCI).

In the mailbag... Things are feeling (or about to feel) pretty bad in real estate, I suppose. Send your e-mail to: feedback@stansberryresearch.com.

"I, like everyone, wonder when the bottom will appear and if it will be bathed in a bright white lite. I just bought a 2/1 condo on the water in hawaii at auction for $110K. If the bottom is far off maybe they will pay me next time to buy one." – Paid-up subscriber Bob

"When you warn of overleveraged reits how much is too much?" – Paid-up subscriber Kris

Ferris comment: Without naming names... running a quick screen produced a list of half a dozen or so with debt amounting to more than four times equity. That seems high.

Regards,

Dan Ferris

Medford, Oregon

November 18, 2008

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame