Mr. Market happy again

Today, we saw a little bounce in the stock market. The German parliament has agreed to pay its $180 billion-plus share of the $940 billion Eurozone bailout. The euro and the stock market are rising again.

That's ironic, isn't it? A move that virtually guarantees the degradation of the euro down the road – bad for both the euro and European stocks – has traders and investors buying both those assets today.

Mr. Market is like that. He buys when he should sell, and sells when he should buy. Ultimately, that's good for us. It creates opportunities to take advantage of his predictably irrational nature. We can buy stocks in March 2009 and sell them, or at least refrain from buying them, in May 2010.

Trader friends of mine covered short positions yesterday and are getting set for a rally into next week, perhaps beyond. After that, they tell me, lookout below...

If you're short the dollar, the events of the last couple of weeks have been painful (more on this in the reader feedback below). The 30-year Treasury yield has fallen from 4.73% on April 15 to around 4.14% yesterday.

I fear for the U.S. dollar over the next several years. But right here, right now, I have to wonder if U.S. Treasuries might not end up like Japanese government bonds. When they were yielding 3%, many said rates could only rise. But Japanese government bond rates fell to 0% and then went negative. You can make a lot of money being long bonds from 3% to 0%. And who likes any kind of bond, government or otherwise, when inflation is in the air? Nobody, for good reason.

But that's the way markets work. They whipsaw the weak hands out, even while delivering somewhat predictable long-term trends.

One of the areas U.S. investors need to look at is emerging markets. Big money is certainly doing so. Abbott Labs said today it'll spend $3.7 billion to buy the generic drug unit of Piramal, an India-based conglomerate. GMO's Jeremy Grantham is among those willing to make a larger-than-average bet on various emerging economies.

That's one of the reasons Grantham likes World Dominator stocks, big global franchises that do large amounts of business outside the U.S. I just wrote about one such company in the May issue of Extreme Value. It's the No. 1 player in seven of the 10 largest markets in the world. And it's cheap, too, selling for a low multiple of free cash flow. Even if the U.S. economy suffers, it could easily rise 50%-100% over the next few years. Porter and Tom Dyson have also written about some World Dominator companies.

I'm sure more than one of you will be quick to point out that, though the World Dominators as a group fell less than the market the last few days, they still fell. Even the Dow fell 89% in the 1929-1932 bear market. Mr. Market hated absolutely everything in the 2008-2009 crash. The only safe place was cash.

But that's the thing about stocks. Most people lose money on them not by picking the wrong ones, but by picking decent stocks and getting scared out of them. Peter Lynch once said the key to making money in stocks is not getting scared out of them. I think the best way for the average retail investor to put that advice into play is by taking positions in companies you know will do just fine over time... Coca-Cola, Procter & Gamble, Berkshire Hathaway, Intel... companies like that. The key is buy when they're cheap enough. When all hell is breaking loose and everybody wants to sell (like in March 2009), World Dominator stocks are a great way to exercise contrarian instinct and still sleep soundly at night. You can make good money AND keep your investment worries to a minimum.

Longer term, I think precious metals, oil and gas, and agriculture represent great opportunities. I went up to Canada earlier this week and found a company making big bets in all three of those areas. I first noticed it more than a year ago, when the markets were pricing in Armageddon. It quickly rose nearly 70%, well above my maximum buy price. As Mr. Market has become more depressed lately, he's brought the company back into buying range. It's loaded with cash, gold bullion, and liquid securities worth more than $4 a share. Right now, it trades for less than that. The full details will be in the next issue of Extreme Value. To sign up for Extreme Value, click here.

The U.S. Senate passed its version of the massive financial regulatory overhaul last night. Ostensibly, our elected representatives are trying to protect you and me from the big bad bankers of Wall Street. But we know what's really up. Big financial regulatory overhauls will translate into bigger competitive advantages for the biggest banks.

At least one professional investor agrees. Jim Hardesty, president of Hardesty Capital Management LLC in Baltimore, says, "The lobbyists are firmly in control of Washington, and the reform efforts are likely to be modest." Hardesty says the big Wall Street companies "can reinvent themselves, and they've proved remarkably adaptive over many market cycles."

Reinventing themselves usually means finding new ways to charge you more while delivering less. They'll raise fees on basic services like checking accounts. They'll cut back debit card rewards. And beneath it all, new regulations will make it harder for new competitors to break into the business and offer you good products at reasonable prices.

"Good products at reasonable prices" seems a fair description of what the financial services industry strives to avoid at all costs. No wonder the government perceived a great political opportunity to "fix" the industry.

In truth, the thing that really needs to be fixed is the typical investor's behavior... But changing behavior is too much work for most folks. They trust the regulators, take on option-ARMs, and suffer the consequences as Goldman Sachs makes billions selling short the products it sells to its own clients.

The regulatory overhaul will create a new federal bureaucracy to protect consumers from things like credit cards, payday loans, and home mortgages. It's nice to want to help people and protect them. But do we really believe this new horde of government employees will protect us any better than the SEC protected investors from Bernie Madoff? I don't think we do.

Even if you think government does a decent job, you have to question the idea the government can protect you from yourself. Government does a better job of lulling you into complacency. Then, its friends in the banking industry ram new toxic products down your throat. Do the folks who borrowed 100% of the purchase price of their new homes in 2005 feel protected today? Not likely, but they really have no one to blame but themselves. Why the new regulations? It's sad and ironic that those whose behavior proved the futility of regulations probably clamor loudest for more regulations.

It's really simple: If you try to protect people from the consequences of their own folly, you are guaranteed to fill the world with fools.

I just finished participating in my first S&A Off the Record conference call. Our monthly Off the Record conference call service puts subscribers in touch with the insiders, the executives, and investors involved in the companies we have recommended. On this morning's call, Resource Report editor Matt Badiali chose to highlight one of the stocks I've recommended in my Extreme Value letter...

Imagine, if you will, a small out-of-the-way company in a mysterious business few people really understand... a company that can invest $650,000 and realize a $200 million profit a few years later.

Well, it's not imaginary... It really happened, and the company on this morning's call pulled it off. I've recommended the stock several times in Extreme Value, and it's in buying range again. It spent a little more than $1 million on one investment that is already worth more than $50 million and could be worth more than $300 million in the next couple of years. The whole company is valued at less than $300 million, so you can imagine what that one investment could do to the share price, which is less than $10 today.

The company has about a dozen investments with that type of potential. It's a dirt-cheap stock with fantastic upside potential, and a safe foundation of cash and liquid assets. To sign up for Off the Record and be the first to listen to this call, click here.

New highs: none.

Some good insults in the reader feedback today. One e-mail I didn't print called me a failed Quentin Tarantino screenwriter. Hurl your best shot at feedback@stansberryresearch.com.

"You guys are such pussies. A little dust in your eyes and you are whining. This nation was built by capitalists who hired real men to do real work. Think about it." – Paid-up subscribers Jamie and Pat White

Ferris comment: I'll meet you out on the Alberta plains any time... I'm certainly not a rough-and-tumble guy. I rarely leave the house. But I wouldn't call what I experienced "a little dust." It's 20 mph winds swirling up dust across hundreds of thousands of acres. They don't turn over the topsoil because they'd lose a good deal of it in a matter of hours. The wind is powerful, and it never stops.

I retreated to the bus along with a former Indian chief who's lived his whole life out there. He said, "I hate the damn dust. I've had enough." Go ahead and sneer at him, if you want. He's built like a rock and could probably fold me in half with one hand. Funny, you admit the capitalists themselves didn't do the hard work. They hired others. Well, I was out there with a bus full of capitalists, not a bus full of workers.

"WOW! What a terrible call you made on shorting treasuries. I've got a half a dozen Digests in by inbox where you guys were saying treasuries HAVE to go down. Saying that you will eventually be proven right won't get you out of this one. The world will eventually end, but I'm not planning to move to Mars anytime soon. I hope I'm one of the few who listened to you on this one." – Paid-up Subscriber Joe M.

Ferris comment: You make an excellent point, but your tone and implication we don't produce good investment ideas is disingenuous.

The excellent point you raise is, how do Treasuries fall if everyone views Treasury securities as a safe haven? Everyone thought Japan was a "sell" when Japanese government bonds were yielding 3%... but yields went down and even negative from there. You make a lot of money buying on the trip from 3% to 0%.

"The dealers who have gold are selling. For U.S. dollars. What are they buying?" – Paid-up subscriber Edwin Hawk

Ferris comment: They're not merely selling. They're earning a spread. They sell at one price and buy at another. I don't know if the country's coin dealers are net buyers or net sellers. It would be difficult to find out. Maybe you could poll the 10 largest gold coin dealers to find out if they're net buyers or sellers of bullion coins. Then, you can get back to us with the results. Good luck.

"You may believe that your definition of inflation is the only true definition, but the WSJ usage is the commonly accepted one. 'The WSJ article under that headline makes the usual novice error of equating upward movements in the price of goods with inflation.'

Google comes up with many references to inflation being the continuing rise in the price level of goods and services. Economic and Webster's dictionary use this definition. Just because Austrian Economics says it is growth in money, doesn't make it universally true." – Paid-up subscriber Jon Parker

 "Dan, I hope that they are growing pot on that farm that you are visiting and you are smoking it. How else do you come up with a statement like 'Whether or not the prices of goods reflect the existence of inflation is a separate issue from whether there's inflation.'

"So the price of goods has nothing to do with inflation in your opinion.

"I find it interesting that you went shopping for a home and were delighted to find one selling for much less than it did a few years ago, but you are convinced that we still have ravenous inflation going on.

"Of course for those of you us not smoking that whacky Canadian weed, the definition of inflation is, 'In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.'

"I don't expect you guys to answer this question because it makes you all look so stupid, but I will try it again.

"If you can drop money from helicopters and the price of goods does not go up, then why wouldn't you do it?" – Paid-up subscriber Joseph Zadeh

Ferris comment: These are a couple of the e-mails attempting to correct me on the subject of inflation. This is a healthy debate. The definition of inflation is an important investor question. You need to come up with an answer if you're going to protect what you've got and earn more.

Checking Google and the Wikipedia for inflation definitions, as the above two subscribers did, isn't a bad idea. We all do it. But it's the first line of inquiry, not the last. You should think hard about what inflation is, what it leads to, and how that might affect stocks, bonds, gold, and other assets. And hey, why not ask the folks who are in the inflation business what they think?

Inflation is the process of making addition to currencies not based on a commensurate increase in the production of goods. — Federal Reserve Bulletin (1919)

I don't see anything about price increases in the Fed's classic definition of inflation. In fact, the term inflation was originally used to describe the increase of paper money in relation to the gold supply. But as paper money became ubiquitous, governments had to steer us away from that definition.

So now, in our world of paper money, everywhere we look, whether its Google, Wikipedia, college classrooms, or newspaper articles, we get the fake, popular definition: rising prices for goods and services. That's a symptom of inflation, not the cause or essence of it.

Inflation is monetary inflation. That old Fed definition above comes from 1919, years before FDR's 1933 gold confiscation. It's from a time when people thought gold was money, not a popular idea today. We're constantly fed price information – like the consumer price index and producer price index – that distracts us from the real issue. The real issue is the Fed has a printing press and has cranked it up higher than at any time in U.S. history. That's inflation. That's what we have today. Perhaps soon its effects will become more widely visible.

"As I live in Salem, I've followed your house upgrade adventures in Medford, OR with interest. I recently experienced the disastrous process that is now involved in obtaining a new home mortgage loan in an OBAMA!-initiated TARP environment.

"Having purchased and sold more homes in the past 30+ years than most people have pairs of new socks, I can categorically state that the mortgage loan process has become similar to that in a totalitarian state.

"The multitude of endless and ridiculous disclosure forms and requirements imposed by the underwriters and banks on honest citizens has everyone being treated the same, credit history and score, notwithstanding. Is this not a form of profiling, where everyone is a criminal unless they can pay cash?

"It seems to me that if you really wish to know what kind of credit-worthiness someone has, looking at their past record of credit payment reliability would be the single, best indicator. But, that's no longer true. It's no longer sufficient to have an 800+ credit score and history of perfect payments on credit/mortgage/loan accounts.

"Instead, banks, underwriters, and mortgage loan brokers want to invade your life and create excessive and unnecessary intrusiveness. And in the process of impugning your dignity, respect, and equanimity, perhaps forcing you to abandon the process out of sheer frustration.

"I have no desire to apply for another mortgage loan under the current political, security, and economic climate. Good luck on the economic and housing recovery, Amerika." – Paid-up subscriber J Dziados

Regards,

Dan Ferris
Medford, Oregon
May 21, 2010