Famed investor Jeremy Grantham has been working for our Extreme Value readers for years, and we didn't even know it.
On December 31, 1999, Grantham made a 10-year forecast. He predicted the rank and return for 11 different asset classes. The results are in his latest shareholder letter (available free at www.gmo.com). And those results are quite impressive.
Grantham predicted returns for U.S. REITs, emerging-market stocks, emerging-country debt, U.S. TIPS, U.S. government debt, international small-cap stocks, foreign bonds, U.S. small-cap stocks, U.S. T-bills, Europe-Australia-Southeast Asian stocks, and the S&P 500.
Grantham's forecast for these 11 asset classes correlated with their actual performances by an astonishing 93%. There's a one in 550,000 chance of randomly achieving the same performance.
How'd he do it? By focusing primarily on a single variable: valuation. He predicted everything would outperform the S&P 500 because it was selling for 33 times earnings, and he was right. (Duh!) He predicted emerging-market stocks would come in at the No. 2 position, despite their correlation with U.S. stocks. They were cheap. Emerging markets came in at No. 1, outperforming his projected annual return by 30 basis points. He predicted U.S. REITS, which were cheap in 1999, would rank in the top three, and they did.
So... even if you want to play the risky game of predicting future asset prices, you can win it if you just do one thing: Learn to identify extremes of valuation. By doing this, Grantham has not only made plenty of money for his clients, but he's managed to avoid every major bubble of the last three decades: Japan in the '80s, tech in the '90s, and the great mega-bubble of the '00s.
Today, like me, Grantham thinks large, high-quality stocks are priced to provide the best returns among all assets. I agree and have been recommending three of them in Extreme Value recently, along with a little-known play on the tidal wave that's set to kick off the next phase of the banking crisis...
The Congressional Oversight Panel says 3,000 banks could be devastated by commercial real estate losses. Harvard law professor Elizabeth Warren says banks that provide small business loans will be hit by a "tidal wave of commercial loan failures." The panel found that, for 37% of the country's 8,100 banks, commercial real-estate loan balances exceeded 300% of total capital, and construction and land loans exceeded 100% of total capital.
Bad times are much worse on small businesses and individuals than they are on politically well-connected big businesses. In Extreme Value, I've recommended a little-known play on the commercial real estate crisis.
As thousands of small and medium-sized banks fail over the next couple of years, another company that's highly dependent on small-business financing will prove to be a great short sale. One-third of its operating income is totally dependent on small businesses and individuals getting loans. As that becomes more and more difficult, this company's profit margins will shrink. Today, the stock's price reflects zero risk... but the commercial real estate tidal wave is going to hit it and make a few smart investors rich. To get access to my unique play on the commercial real estate decline, click here.
If you've ever read Murray Rothbard's brilliant book, The Mystery of Banking, you know rising cash balances are a basic feature of inflation. Since inflation means too much currency exists, no matter what you do with it, it has to pile up somewhere. One place cash is piling up like crazy is corporate balance sheets...
A majority of S&P 500 companies, 262, increased cash and short-term investments 78% from a year earlier to a combined $1.19 trillion. The entire S&P 500 increased cash 14% to $2.18 trillion. Meanwhile, capital spending fell 42%. In short, no one wants to spend money. Every business is nervous about the economy and probably more nervous about government regulation. So they are all holding on to every penny they can.
To create wealth and omelets, you must break eggs. Until businesses, especially banks, resume lending and spending, unemployment will remain near current levels, and we won't see any wealth creation. Money creation? Yes. Wealth creation? No.
Maybe Komrade Obama's awareness of the commercial real estate crisis caused his sudden "change of tune" regarding big business. He's now a self-proclaimed proponent of free markets. Ha! In a February 9 interview with Bloomberg BusinessWeek, Obama said he doesn't begrudge Lloyd Blankfein (CEO of Goldman Sachs) and other high paid bankers their big bonuses because "there are some baseball players who are making more than that and don't get to the World Series either, so I'm shocked by that as well."
Obama then says he doesn't begrudge success or wealth in general because it "is part of the free-market system" and his administration is "fundamentally business-friendly." This interview hasn't hit newsstands yet, but it promises to be entertaining. Since when is nationalizing the auto and mortgage industries, limiting executive pay via a "pay czar," forcing government money into private businesses, taxing successful businesses to fund failing ones, etc. considered "free market" and "business friendly?"
Of course, the truth about Komrade Obama's changing rhetoric is that rhetoric is all he has. He hasn't changed his ideas on business because he never had any to begin with. The only thing he can do well is make speeches. He always knows what to say, but he never knows what to do.
Komrade Obama is like a charming 17-year-old boy, who is dating your daughter. When he's around you, he never says the wrong thing, and you buy his act. But when you're not watching him, you know somebody is getting screwed.
In his recent Penny Stock Specialist report, editor Frank Curzio recommends his most speculative pick in a dozen years.
The stock was trading at $47 and fell to less than $9 last week after management suspended its dividend. Five institutional analysts downgraded the stock to "sell." Plus, the company is close to breaching its debt covenants, which means a bankruptcy filing is possible. Frank says bankruptcy isn't likely. The company has more than enough cash to cover its interest. In fact, Frank thinks this company will reinstate its dividend within nine months. But the market obviously disagrees. This is the perfect situation to buy a quality stock for less than $10 after a temporary scare.
Frank sees more than 100% upside in this stock because he's seen the exact situation before. This company reminds him of chemical manufacturer Ashland and auto-parts company American Axle & Manufacturing in early 2009. These single-digit companies were also close to bankruptcy. After management restructured debt and turned around business, these stocks surged more than 500% in less than a year. To get Frank's latest pick, click here...
New high: Steak 'n Shake (SNS).
In the mailbag... Kudos to Jeff Clark and a question about the "$59 computer." Send your email to feedback@stansberryresearch.com.
"On Feb 2/10 I subscribed to S&A Short Report. On Feb 3/10 I decided to give it a 'go' and [bought] 20 Feb 20/10 CAL puts @ $1.03 .On Fri AM (Feb 5/10 ) I made a mistake and sold all 20 contracts (instead of only half as per Jeff's suggestion) @ $2.90 !! Made $ 3,700 which almost paid for my S&A Short Report yearly subscription. When I try to do the annualized return calculation I get fouled up in all the zeros (same as when I try to illustrate how long in years a trillion seconds is – actually approx 31,710, don't think the boys in the caves were even working on discovering fire back then), so I'll leave the a.r. calc to you guys. Thanx for the great start." – Paid-up subscriber Alex
"I just subscribed to the Phase 1 publication and could not find the name of the company that supposedly has a inside track in helping to get this new computer manufactured. Can you shed some useful light to me, for you say that this 'company' holds about at least 16 patents thereon?" – Paid-up subscriber Gordon Tomm
Goldsmith comment: To see what Gordon is talking about, check out yesterday's Digest, here. Gordon, just read The $59 Computer Revolution under the Phase 1 Special Reports section on the Stansberry & Associates website.
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Miami Beach, Florida
February 11, 2010