How We'll Know When It's Really Time to Worry About Stocks

OPEC's first defection... The big move into China officially begins... 'Are you scared?'... How we'll know when it's really time to worry about stocks... Not even the 'Melt Up' will save these firms... P.J. O'Rourke takes over the mailbag...

The news keeps getting worse for the Organization of the Petroleum Exporting Countries ('OPEC')...

The Saudi-led oil cartel's recent production agreement appears to be in jeopardy. Yesterday, we noted that global oil production rose unexpectedly last month, suggesting some OPEC members have quietly "opened the taps" again.

Today, we have more evidence that the group's commitment is wavering. In an unusual move, one of its members has officially defected. As Bloomberg reported this morning...

Ecuador has dealt a blow to OPEC unity by announcing it will start raising oil production this month, arguing it needs the money.

OPEC has for years cheated on its own agreements, particularly when oil prices fail to recover after an output cut. But Ecuador has taken the rare step of saying publicly it will increase production, making it impossible for the group to conceal the desertion.

The Latin American country won't be able to meet its commitment to lower output by 26,000 barrels a day to 522,000 a day, as agreed with OPEC last year, Oil Minister Carlos Perez said in an interview with Teleamazonas late Monday.

"There's a need for funds for the fiscal treasury, hence we've taken the decision to gradually increase output," Perez said. "What Ecuador does or doesn't do has no major impact on OPEC output."

Now, to be fair, Perez is right...

Ecuador is the third-smallest OPEC producer. And this extra production represents less than 2% of the group's total production cuts. But we wouldn't dismiss its importance.

The cuts clearly aren't working as planned... Oil prices have given up virtually all their gains since the deal was announced in November.

Meanwhile, Ecuador isn't the only OPEC member in serious financial trouble. Larger producers like Venezuela, Angola, and Algeria are struggling, too.

How long are they likely to stand idle as other members ramp up production again? Our bet: not long at all.

The 'smart money' is now moving into China...

"It's a game changer for China investment because one year from now passive funds have to buy. They have no option. [We] can move between now and then."

As regular Digest readers can likely guess, this quote is referring to index-provider MSCI's recent decision to include Chinese stocks in its benchmark emerging markets index.

But it doesn't come from our colleague Steve Sjuggerud.

Of course, you'd be forgiven for thinking so... Steve has been saying the same thing for months. As he explained in the May 6 edition of our weekend Masters Series...

This is big... Right now, roughly zero percent of American retirement assets are invested in local Chinese A-shares. But that will all change when MSCI includes local Chinese stocks in its indexes.

What will happen is – whether they realize it or not – Mom and Pop America will end up owning Chinese stocks in their retirement funds... Ultimately, hundreds of billions of dollars will flow into Chinese stocks as this process unfolds – regardless of whether they're a good buy or not.

So my suggestion is simple – get your money there first!

But today's quote comes from Anthony Cragg, a senior portfolio manager at Wells Fargo Asset Management. He's just one of several active fund managers who are now turning their attention to domestic Chinese stocks – or "A shares" – for the first time. As news service Reuters reports...

Global fund managers are ramping up their presence in China, aiming to be well ahead of next June's inclusion of mainland-listed stocks into MSCI's benchmark index that is set to boost investment into the economy's $8 trillion equity market.

Wells Fargo Asset Management, Neuberger Berman, Fidelity International and Robeco are among fund houses sharpening their stock-picking skills in mainland "A" shares and hiring staff in China to get a first-mover advantage before the rebalancing triggers a flood of passive index-tracking funds to that market.

[Cragg] visited China just two weeks after MSCI decided on June 20 to include 222 Chinese big-caps into its Emerging Markets Index. MSCI will start phasing in Chinese shares from June 2018 but Cragg is already in search of the country's "future blue chips"...

Active funds can select the companies they think have better growth potential and add them to their China-focused funds now.

In other words, the "smart money" is now moving into China in droves ahead of this trend, just as Steve predicted. And his True Wealth China Opportunities subscribers are already in a fantastic position to profit as they do.

'Are you scared?'

Regular readers know Steve has also been bullish on U.S. stocks. He believes a "Melt Up" will deliver massive gains before the bull market finally ends.

But we've heard from several folks who are skeptical... or downright scared. After all, stocks are back near all-time highs, and they're as expensive as they've been in years.

If you're among them, Steve has a message for you: It's still too early to get bearish. As he wrote in yesterday's edition of our free DailyWealth e-letter...

Stocks are having a great year. And the S&P 500 has returned more than 300% since bottoming in March 2009.

These big gains have led to worryingly high valuations... Based on one measure, the S&P 500 just hit its most expensive level since 2000.

That is, the S&P 500's price-to-sales (P/S) ratio just hit its highest level in 17 years.

This ratio is a simple valuation tool... It might even be the simplest one. It's useful, too... Since it looks at the "top line" number – before all the math that gets to the "bottom line" – it lowers the risk of accounting shenanigans. We call it "one of the best ways to measure real value in the stock market."

At the market bottom in 2009, the S&P 500's P/S ratio fell to less than 1. Stocks were cheap.

But that has reversed since... Stocks have soared, and the P/S ratio recently rose to about 2. That's its highest level since 2000. Take a look...

Seeing prices near dot-com-bubble levels is frightening...

But as Steve explained, this chart alone is not a valid reason to sell...

Consider this... The P/S ratio just broke above 2. During the 1990s bull market, the P/S rose above that level in December 1998.

Was selling then a good idea? Heck no! You would have missed out on another 26% gain in the S&P 500. And the Nasdaq Composite Index went on to soar another 131% from there, too.

More important, Steve noted that the P/S ratio is just one way to value stocks. And it doesn't tell the whole story...

The P/S ratio isn't the only way to size up stock prices. If we look at two other popular measures – the price-to-earnings (P/E) and price-to-book (P/B) ratios – we see something different...

These two measures are still well below their 2000 bubble peaks. The P/E ratio would need to increase 34% to hit its 2000 high... And the P/B ratio would need to rise 59%.

These metrics don't say that stocks are cheap. But they aren't flashing bubble warnings, either.

To Steve, the bottom line is simple: Yes, stocks are getting expensive... But high valuations alone don't kill a bull market. And all the fear and worrying among investors tells him the Melt Up is still ahead...

Please keep in mind, the final innings of a great bull market often deliver massive gains. I call this phase the Melt Up.

You don't want to get scared like everyone else today. You want to be on board for the Melt Up phase.

When everyone else STOPS worrying... when everyone else is PILING INTO the markets, not PULLING OUT of the markets... THAT'S when we want to worry. We're not there yet.

The Melt Up is here... Investors are scared, but the trend is up. It's a perfect setup. Based on that, the smart move is to stay in stocks until that changes.

Not even the Melt Up will save these firms...

However, not every stock in the market will benefit from the Melt Up. As we explained last week, Steve believes there will be big winners and losers as the final innings play out.

Porter agrees... In fact, he says one group of stocks in particular – many of which are household names – are likely doomed no matter where the market heads next. Even if the Dow soars to 50,000 or more, these companies are unlikely to survive.

Porter shared all the details in a short presentation with readers last week. If you missed his e-mail, you can see it for yourself right here.

New 52-week highs (as of 7/17/17): AllianceBernstein (AB), Boeing (BA), Bancroft Fund (BCV), Blackstone (BX), iShares MSCI Singapore Capped Fund (EWS), iShares U.S. Aerospace and Defense Fund (ITA), Lockheed Martin (LMT), Microsoft (MSFT), AllianzGI Equity & Convertible Income Fund (NIE), Naspers (NPSNY), NVR (NVR), ProShares Ultra S&P 500 Fund (SSO), Stanley Black & Decker (SWK), TTM Technologies (TTMI), Verisign (VRSN), and Weight Watchers (WTW).

In today's mailbag, several readers share their thoughts on Digest contributing editor P.J. O'Rourke's new magazine, American Consequences. Send your questions, comments, and concerns to feedback@stansberryresearch.com. As always, we can't provide individual investment advice and we can't respond to every e-mail, but we read them all.

"[P.J.,] I had a relatively brief journalism career because of you, dating back to my junior year of high school. Sometime in 1986, my newspaper adviser gave me a copy of Rolling Stone containing your story about the Philippine revolution. I decided then and there that I wanted to be a reporter. That didn't pan out as much as I would have liked. I left newspapers for teaching and now administration, but my admiration for your body of work remains. I loved All the Trouble in the World and Republican Party Reptile. They're really great books.

"I'd describe myself as more 'radical centrist pro-American humanist' than libertarian, but our philosophies do overlap now and then. I'm happy, therefore, to see that you're still in the game, and I'm delighted to subscribe to American Consequences. Keep the good work coming, and godspeed." – American Consequences subscriber Chris Blair

P.J. O'Rourke comment: Dear Mr. Blair, thank you for the kind words. But my wife would say it's all for the best that your journalism career didn't work out and that you wound up doing something worthwhile, respectable, and important. Come to think of it, I'd say the same thing myself.

And hooray for your political views. We don't need any "wishy-washy extremist anti-American human-haters." I'd vote for you whether we agreed or not.

"Mr. O'Rourke: I wanted to thank you for what you are doing. For the last eight years I have been editor of a small-town newspaper in northwest Florida. It has been in publication since 1888. Before that I had a generally unsatisfying (though brief) career as a criminal defense lawyer in New Orleans. I have been a reader and admirer of your writing since your days at the Lampoon, and my late father thought your Parliament of Whores was the best book he'd ever read about American government. He frequently quoted from it.

"I get hundreds of daily emails from 'news' organizations, think tanks, and advocacy groups, and it generally takes me about ten seconds to assess their worth before deleting them. I would have done the same with American Consequences (which a friend posted on Facebook), but for your name on it. I look forward to reading it. David Mamet once quoted Mark Twain as saying 'if you want to understand Man, open a country newspaper.' I now realize that Twain meant it as a curse. Thanks for your time, I wish you success." – American Consequences subscriber Bruce Collier

P.J. O'Rourke comment: Dear Mr. Collier, yes, and Mark Twain was probably right. But it's a "blessed curse." Small-town newspapers are the last bastion of objective truth – because everybody knows if you aren't telling the truth about who died and the new zoning regulations. And I take back what I implied to Mr. Blair, that journalists are worthless, shady, and unimportant. There are exceptions. And I think northwest Florida has got one.

"What a terrible choice of cover for American Consequences! Not only do I want to read Stansberry analysis, it is the cornerstone of my family's investing strategies and I highly value the information you produce. But no way am I interested in a publication that starts off with an image of a scantily clad pole dancer. What is that doing on the cover of my investment newsletters??

"I am a conservative woman and I am the primary manager of my family's investments, so in my family, I'm your audience. My teenage son is also learning, and enjoys reading Stansberry and Bill Bonner newsletters. Good for him! At his age, to be learning the specifics of investing but also the need to be responsible for one's own financial future! But I won't be showing him this one. So however thought provoking the articles might be, they are of no value if they are not read. Sadly, I am probably in the minority on this. Nevertheless, I implore you in the future to use more respectful images." – Paid-up subscriber Debbie Wark

P.J. O'Rourke comment: Dear Ms. Wark, as the editor in chief of American Consequences, the fault is all mine. You're right and I'm wrong. In fact, I already knew I was wrong because I caught heck from my teenage daughter about that cover. I could go into all sorts of lengthy explanations and excuses, but I think I'll stick with "men are stupid."

I don't want to lose my sense of humor – a striptease joint with its own cryptocurrency is pretty funny (and maybe an indication that cryptocurrency is funny money). But... a benign and chaste old ad clip for an early 20th century burlesque house would have made the same point in a more tasteful way.

Maybe men will never grow up – but people need to keep telling us we should. Otherwise, who knows what worse foolishness we'll get up to. Thank you for taking the responsibility for telling me.

Regards,

Justin Brill
Baltimore, Maryland
July 18, 2017