Nine days down...
Nine days down... Saved the best for last... Why you should never buy stocks (really)... The simple secret to earning 30% a year in bonds...
I made it.
Today is the ninth Digest I (Porter) have written in a row. Sean Goldsmith returns from vacation on Monday. Over the last nine days, I've worked hard to give you a summary of what I believe are the most valuable ideas, strategies, and secrets I've learned (so far) during my career in financial research. Ideally, my staff and I will work on refining these ideas, expanding them, and perhaps turning the collection into a short book – a kind of introduction to Stansberry Research.
But I've saved what I truly believe is the most valuable secret for last: I firmly believe that most individual investors should never buy stocks. That probably seems ironic coming from a guy who has spent his entire adult life researching investments and advising people from around the world on markets. I've recommended hundreds of different stocks. Was I lying then, or am I lying now?
No, I'm not lying. In fact, I'm telling you such a huge secret that it could easily lead you to cancel your subscription and never buy a stock again. I'm telling you this secret for the simple reason that it's what I would like you to do if our roles were reversed.
That's how I do business. And I know that if I serve my subscribers in this way – by that exacting standard – everything else in my business will take care of itself. The folks who appreciate my efforts will stay. The folks who don't weren't going to renew their subscriptions anyway. So... whatever you decide to do with this information, I hope you'll read carefully and think deeply about what I'm about to tell you.
Stocks can be fantastic investments. And I try my best to only recommend the ones that will make you a lot of money. But the hardest part of my job is overcoming unbelievably bad management teams. If more investors really knew what happened in the offices of the CEOs of publicly traded companies, I promise... you'd never buy a stock again.
I've personally seen deal after deal executed – involving billions of dollars – that had zero chance of ever creating any shareholder value. Likewise, I've seen CEOs refuse to make simple, logical, and necessary changes or divestitures that would have, in some cases, saved their companies from bankruptcy.
I'm involved in a situation right now (you'll hear more about it in the upcoming issue of my Investment Advisory) where I'm begging the management team of a great business to make a decision about its asset portfolio that's completely obvious, even to an outsider like me.
And yet, the suggestions in my report – which are clearly in the best interest of all shareholders – will likely be treated like an attack, an affront on the dignity of the management. The truth, of course, is that if the management team had any real dignity, it would be doing a much better job of managing its asset base.
The fact is, 90% of the time, CEOs do what's in their best interest – damn the torpedoes. That means trying to garner as many assets as possible, in the blind hope that something good eventually happens with one of them. And often enough, what's in their self-interest is diametrically opposed to what their shareholders deserve.
What won't you often see? Management teams giving themselves an honest appraisal. Not even Berkshire Hathaway founder Warren Buffett. He wrote publicly for many years that the test of his skill as a manager was to outperform the S&P 500 on an after-tax basis for any rolling five-year period.
For the first time in his entire career, he didn't achieve this goal. So what did he write in his 2014 letter? Going forward, he promised to beat the S&P 500 every six years.
He didn't say anything about his disastrous investment into ConocoPhillips at the top of the oil market in 2008 or his $10 billion investment – the largest of his entire career – into lackluster tech giant IBM. Instead, he made excuses about the size of his portfolio and "moved the goalposts" – something he had spent his career criticizing other CEOs for doing.
Keep in mind, Buffett could spin off any of the assets he doesn't want to manage anymore and quickly regain a growth rate that's more appropriate. But will he ever do so? Not a chance. And that's from the management team at one of America's most respected and beloved companies. What can you do about it? Buffett recommends only buying businesses that, as he says, "could be run by monkeys." After all, he warns investors, "sooner or later, that's what will happen." Too bad nobody realized he was making a prediction about Berkshire.
Is that a cheap shot? I don't know. Probably. But it's amazing how every management team – even Buffett – can devise wondrous excuses for miserable performance. What can you do about it? Well, that's easy: Don't give them any cheap capital. They don't deserve it.
"All right, tough guy," you're probably saying. "If we're not going to put our money into stocks, then what should we do? We can't trade commodities, we'll get killed. We can't hold cash, the Fed is printing the dollar into oblivion. Fixed income? You must be kidding – how can anyone survive on earning less than 6% a year?"
Yes, the answer is fixed income. And you won't be surprised to learn that it's a kind of fixed income that your broker probably won't sell you... at least, not easily. It's a kind of fixed income that offers you incredibly high rates of income – more than 10% – and huge capital gains, too... capital gains that can rival (or even exceed) the largest gains you've ever made in stocks.
But before I get into the details of how to make this work for you, I want to pause for a moment and talk about why this works.
American managers act like capital is free. They make terrible capital-allocation decisions. Far from "allocating to value," they constantly allocate to popularity. As a result, they chronically overpay for super-low-quality assets. The way you can make this work for you is simple: You lend them the money.
Capital isn't free, of course. And if you take a more senior position in the capital structure (bonds versus stocks), you can make sure that you nearly always get paid. The management team doesn't have the option of whether to reward you for your investment or not. It must pay the coupon on your bond, or else the company will go bankrupt, its assets will be sold, and its employees will be out of a job.
I would bet that more than 90% of my subscribers have never purchased an individual corporate bond. That's madness. In fact, if I could, I wouldn't let any of my customers buy stocks until they had invested in corporate bonds. Bonds are far safer than stocks. The average recovery rate on corporate bonds in default is around $0.45 on the dollar, according to financial services firm Standard and Poor's.
No, you don't want to try to buy a bond of a company headed for bankruptcy. Of course not. Recovery in bankruptcy is always uncertain and there are no guarantees, especially not these days, when the government and the courts are doing crazy things.
But it's an indication that, for most bonds, at the very worst, you're going to get back a good portion of your money. That's especially true if you follow my advice, which is to never pay more than $0.70 on the dollar for corporate bonds. But... I'm getting ahead of myself.
There are really three things you have to know about buying corporate bonds the right way. The right way means:
| • | You're going to get more than 10% a year in yield. |
| • | You can't lose more than 35% of your investment, no matter what. |
| • | There's an overwhelming likelihood that you'll make at least 100% total return over three years. |
That's three times more than you'll make in stocks on average. The reality is, most individual investors make almost nothing (less than 3% annually) in stocks, because they always sell at the worst possible time. I say that based on studies like those done on mutual funds (by research firm Dalbar) and by a big study conducted on actual brokerage account results (by investment manager Blackrock). Judging by our feedback e-mail and conversations I've had over many years with both investors and brokers, I believe the same facts apply to most (not all) of my subscribers. My advice? At the very least, make bonds the center of your portfolio going forward.
When you own bonds instead of stocks, there are three layers that protect you from making bad decisions. First, you don't have to worry about bonds going to zero (90% of the time). You are legally entitled to your coupon payments and to your share of the company's assets if it can't pay you in full.
Second, if you will learn to buy at the right time (when the bond market is in distress), you will receive very large amounts of income. This makes it hard to lose money overall. Like the "rich man" in the famous Richard Russell essay, having a rich stream of income makes you patient and allows for you to wait until the perfect deal comes along.
And third, bond investments normally take several years to mature. This encourages you to avoid overtrading and, again, to wait until exceptional deals appear.
But... rather than blather on more about theory... I'd like to show you a real example. We'll use MGM again, because it's a company almost everyone understands. The Las Vegas Strip-dominating hotel and casino company is one of our favorite "trophy asset" businesses.
If you take a look at the company's five-year share price history, you'll discover that MGM's shares got clobbered during the 2008-2009 financial meltdown. The shares have since rebounded about 300% from their average price during 2009 (around $10).
I discussed why this happened in yesterday's Digest: the company built out a massive expansion (City Center) at exactly the wrong time. But... it still had great assets it could easily sell and it didn't have too much debt. In the middle of the crisis in 2009, the company sold one of its lowest-quality hotels (Treasure Island) for $14,000 per hotel room. Assuming it only got the same value for its more upscale hotels, the company's Vegas assets alone were worth far more than all its debts. And that assumes fire-sale pricing and ignores the company's substantial assets outside of Vegas and in China.
MGM was suffering a liquidity crisis, not a solvency crisis. And that meant buying its debt was safe. You couldn't say the same thing about its stock. Investors had no idea if management would get new funding – if it would be able to keep the "wolf" at bay. Before buying its shares, you needed to wait until you could see sustained improvements in its revenues and cash flows. That's what we did.
On the other hand, buying its debt was always safe. Because no matter what stupid thing management did next, the hotels and casinos were still going to be there... And they were extremely valuable, as the 2009 sale of Treasure Island proved.
By early 2009, MGM bonds were trading for less than $0.50 on the dollar. They hit bottom at $0.30 on the dollar. Of course, nobody can know when markets will bottom and what the best available price will be. And we won't pretend that looking back we could have gotten the "low tick" in MGM's bonds.
But any price below $0.50 on the dollar would have qualified as a world-class opportunity. At that price, the yield on the bonds would have been 15% annually. That's like Santa Claus showing up at your office with a big sack of free money. Or as I like to say about really obvious investments: horse, meet water.
Only three years later, these bonds were trading back at "par" – 100 cents on the dollar. Over three years, these fully collateralized bonds would have doubled your money. And you also collected another 45% in coupon payments. In my view, earning 145% in three years – without taking any substantial financial risk – is a far better deal than buying any stock...
Sure, MGM's stockholders have done well, too. The stock is up about 150% over five years. But who knew back then if management could right the ship? Who knew what stupid thing it would do next? Who knew how long it would take?
That's the beauty of these deals... As bondholders, we truly didn't care what management did or didn't do. It was up to them to pay us or lose everything. It's like the movie Goodfellas. When the mob lends you money, you have to pay them. Recall the scene where the mobsters burned down the poor guy's restaurant? Oh, business is bad? Too bad, pay us. Oh, a bunch of jerks ran up big tabs and won't pay them? Too bad, pay us. Oh, someone burned down your restaurant? Too bad, pay us. Bondholders have the same exact view. Oh, global financial crisis hurt your business? Too bad, pay us.
If those big returns available in stocks are too irresistible, there's nothing stopping you from combining equity and debt into a single position. If you're fairly confident that management can bail out the ship, you can simply buy shares with the discounted portion of the bond.
Corporate bonds typically trade in face values of $1,000. So if you bought MGM's bonds at $0.50 on the dollar, that would have left you with $500 or so to buy shares. At the time, the stock was trading for less than $10. To make the math easy, let's say you got shares at $10. So you have a bond with a $1,000 face value (purchased at $500) and 50 shares of stock for a total investment of $1,000.
Here's the best part: No matter what happens to the shares, you're going to get all of your capital back, because those bonds mature in 2016 and then the company has to pay you back your $1,000. Even though the stock was really risky back then, you were protected. By today, the bond would have paid you $375 in coupons... and it's trading at a premium to face value. And the shares would be worth roughly $26 each, or $1,300, for a total return of 167% over five years – far more than 30% a year. And again, you really didn't take any risk in this trade.
There are, of course, plenty of pitfalls and problems associated with investing in corporate bonds. The biggest problem is that high-quality assets like MGM's aren't often available as collateral on bonds yielding more than 10%, let alone 15%. There is, however, a regular cycle in the corporate-bond market. Once every seven to 10 years, the market completely blows up. When bond liquidations start, even the highest-quality issuers will see their bonds trading at big discounts to par. A few rules of thumb can help you easily time these cycles.
First and foremost, you want to watch the spread between high-yield corporate bonds and U.S. Treasurys. This will generally tell you whether corporate bonds are distressed or – as they are now – trading in the clouds.
As you can see in the chart below, the spread between high-yield bonds and U.S. Treasury bonds has rarely been this small. The last time it was this small was 2007. When capital is this cheap and easy, you simply must stand aside from this market, as far too many loans are going to be made to far too many low-quality companies. The result will be a huge wave of debt defaults at some point between 2015 and 2019. We can't know when it will happen – but we know it will happen. Just look back at history...
This chart, from the U.S. Federal Reserve, shows the spread (the difference) between so-called "risk-free" bonds (based on U.S. Treasury bonds with a similar duration) and the Merrill Lynch high-yield corporate-bond index. This is the standard measure of corporate credit conditions. When the spread is low, credit is widely available and cheap. When the spread is high, credit is tight and can be incredibly expensive. Corporate-bond investors should wait to buy corporate bonds when credit is tight and attractive yields abound.
There's something about watching and waiting on the bond market to "roll over" that I really enjoy. This is a when investment, not an if investment. All we have to do is be patient. We know that the feckless, reckless, and stupid management teams running most American companies will borrow too much money and end up in a jam.
It happens every eight years or so. That's about perfect timing for patient investors, as most corporate debt is issued for periods of less than 10 years. You can "lock in" a solid rate of return buying bonds when they go on sale and are trading for less than $0.70 on the dollar that pay more than 10% annually. If you begin to do this, I promise, you'll buy far fewer stocks. You'll make a lot more money as an investor. You'll take dramatically less risks. And you'll produce way more income.
Now, I know a lot of you may be scratching your head at what I've written here. After all, no one has issued more adamant warnings about the bubble that has developed in the bond market. And yes... now is not the time to make big investments in the corporate-bond market.
But this essay isn't about what to buy today or tomorrow. I want you to recognize the incredible opportunity corporate bonds represent when the conditions are right, when you can get them at the right time and price. Remember, at some point, all markets turn around. After the bond market collapses, most investors will want nothing to do with fixed-income investments. That's when we'll find lots of great opportunities in this market... ones that meet all three of my guidelines for buying corporate bonds.
How do you buy bonds? And which exact ones should you buy? Don't worry. As you may know, we closed our bond-focused service, True Income, because of the imminent danger I see in the bond market. You can be sure... when bonds begin to look attractive again, we will re-launch True Income. During the last cycle, we did great – we made 81%, on average, in 2009-2010. And as you may have noticed, the Rite-Aid bond we recommended way back then is No. 2 in the Stansberry & Associates Hall of Fame at the bottom of every Digest.
If you want to go forth on your own, remember to focus on companies with lots of very high-quality and easily marketable assets. Judging collateral is a lot different than judging an operating business. You have to think like a pawn dealer: how hard would it be to unload these assets if the idiots running this business really screw the pooch? That's a far different question than figuring out a reasonable price to pay for future cash flows, or brand value, etc.
You'll see me writing far more about bonds in the future than I have personally in the past. More and more, I believe they're far better investment instruments for most investors. The funny thing is, most brokerage firms make it very difficult for individuals to buy high-yield corporate bonds. Most won't even tell you what bonds are available. And most will only sell you the bonds you want if you're able to tell them the precise CUSIP number of the bond (its trading symbol). That's the best indicator of all. Wall Street's smart money doesn't want you figuring out the best deals in the bond market, which, by the way, is vastly larger than the stock market. Interesting, isn't it?
Yesterday, we published feedback from subscriber Joseph Simon. I didn't have time to respond to it yesterday. But in a P.S. that followed his note, Joseph added that he lives in Buffalo. It's hard to imagine a tougher life than trying to deal with 7th and 8th graders in a city school all day... in Buffalo... and then coming home to a small apartment, filled with young children... while coping with $50,000 in debt.
Obviously, I know there are plenty of worse outcomes, and clearly Joseph enjoys his family and his work. I found this note deeply inspiring. It helped me to remember, once again, that there are lot of "Josephs" out there – honest, hard-working people who want a better life for their families – and who've come to depend on my business (and me) to help them reach their financial goals.
Joseph, I can't promise to always be right, but I can promise to always try my best, to never publish any advice I wouldn't want my own parents to follow, and to treat my customers the way I'd like to be treated, if our roles were reversed. I hope that's enough.
Well... that's it. It's 1:15 AM on Friday. Later today, I'm flying to Knoxville, Tennessee, then driving up into the hills to Scott County – almost to Kentucky. I'll drop off my son, Traveler, at my parents' "cousin camp." It's a weeklong family reunion for all of their young grandkids, culminating in a wonderful American tradition: the small-town Fourth of July parade, carnival, and fireworks display.
Missing from this year's festivities will be the patriarch of Scott County and a longtime family friend, Howard Baker. He was one of the most decent human beings I've ever met, and the farthest thing from a typical politician you could imagine. He was the first notable person to ever tell me I had a bright future ahead of me. He set a wonderful example of how you should always treat other people – with patience, kindness, and respect. He will be sorely missed.
New 52-week highs (as of 6/26/14): Alcoa (AA), Bank of Montreal (BMO), C&J Energy Services (CJES), Dorchester Minerals (DMLP), Enterprise Products Partners (EPD), GW Pharmaceuticals (GWPH), Coca-Cola (KO), Eli Lilly (LLY), PowerShares QQQ Fund (QQQ), Integrys Energy Group (TEG), Teekay LNG Partners (TGP), Two Harbors Investment (TWO), ProShares Ultra Utilities Fund (UPW), U.S. Commodity Index Fund (USCI), Invesco High Income Trust (VLT), Vanguard Natural Resources (VNR), and short position in Washington Prime Group (WPG).
In the mailbag... finally... many of you bothered to write. I'm sincerely appreciative and, frankly, blown away by the kind words you've shared. I hope you'll be half as kind during the bear market that's coming. Either way, I'll continue to do my best for you. If you've never written to me, please don't let your subscription expire without at least saying hello. It only takes a minute: feedback@stansberryresearch.com.
"I often feel that I've been owing you a 'report card' on my progress in the last 10 years. Your plea for customer feedback in the last few Digests made me do it! The truth is your work has been a big inspiration for me... In 2003 I began managing what was then a material amount of money. With the wind at my back and with more luck than brains I managed to compile a pretty decent track record. This performance attracted the attention of a small Portuguese asset management company.
"In 2006 with my investment gains and a loan from my family I bought a stake in this company. They were managing $50 Million at the time. Fast forward to 2008 and my world was completely turned upside down. The tragic circumstances of how I lost my father were devastating... Without time or space to mourn my father's passing, I had to take control of a fledgling textile business at the same time as the financial markets were facing the abyss... To construct our portfolio I've been following the tried and true principles that you diligently keep repeating in your monthly newsletters and Friday Digests.
"As any aspiring individual keen on continuous improvement I'm an avid reader... and I can honestly say that from the dozens of prestigious authors and investment managers that I follow, your work has resonated with me the most. The little asset management company I bought a stake in 2006 is today the biggest independent asset manager in Portugal with a little more than a billion dollars under management. We are clients of several world-class investors such as John Paulson, Michael Hintze, Mohnish Pabrai, Kyle Bass and others. I follow very closely the investments and thought process of these investors, I'm present in every conference call with my notes filled with questions... so when I say your work impresses me, that is your benchmark.
"However, from all the prolific investment insight you provide it was your libertarian points of view, the intellectual honesty, your relentless focus on improving your products and putting your customers first that have influenced me the most... In the public company investment arena I've followed you in several investments such as Hershey's, MGM Resorts and Activision to name a few. Another aspect of my investment process that you completely revolutionized was put selling. Thanks to you I now act as an insurance company underwriting risk. As you can see you have been a very big influence on me, not only on how I select investments but on how I treat my customers, conduct my businesses and strive to be a better person. I sincerely thank you." – Paid-up subscriber V.F.
"As a career medical school teacher I never agreed with your position on education, but your explanation on 6/25/14 clarified what you mean and I agree. What is interesting is you are proposing what is called a 'flipped classroom,' which is the rage in education right now, including medical schools." – Paid-up subscriber James Smith, MD
Porter comment: I'm painfully aware of how poorly I'd explained what that meant... and I'm glad I was finally able to get the right message across. What can I say? I'm a lousy teacher.
Regards,
Porter Stansberry
Baltimore, Maryland
June 27, 2014
Porter on gold and silver...
In today's Digest Premium, Porter discusses the fundamental differences between gold and silver... And he offers his predictions on where the prices of the two precious metals are headed next...
To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.
Porter on gold and silver...
As you know, gold and silver are precious metals. But silver is also an industrial metal. Therefore, their futures are different.
Gold is a barometer of the market's expectations of the U.S. dollar. When you talk about the price of gold, what you're really talking about is the strength or weakness of the U.S. dollar. Ninety-nine out of 100 people don't understand this and never will. They don't understand that gold and the dollar are a ratio.
The gold supply doesn't change by more than 1% or so a year. So gold's so-called supply and demand dynamics are completely irrelevant. The only thing that matters is whether people believe the dollar is going to be worth more or less next year. That's all. And right now, people believe the dollar is going to be worth more next year.
The energy boom in the U.S. has transformed the dynamics of the dollar in the global economy. It has made the dollar much more valuable, and it has made emerging-market commodity-based economies much weaker. Therefore, I expect the price of gold to continue to decline.
Silver has a whole different set of dynamics. Collectors, hoarders, and people who are afraid of the dollar purchase it. But it also has a lot of industrial uses. The supply dynamic of silver does matter, and that is primarily why the price of silver is so much more volatile than the price of gold.
The silver-to-gold ratio does not matter a single iota unless there is fear of the dollar. Right now, there isn't fear. So we'll likely see silver get a lot cheaper both in nominal terms and also in terms of the silver-to-gold ratio. The silver-to-gold ratio peaked in the early 1990s at 100:1 (meaning 100 ounces of silver was worth one ounce of gold). I don't think we're going to get that far again. But I wouldn't be surprised at all to see silver trading at a ratio of 60:1 or 70:1 or 80:1 in this kind of environment.
The time to buy gold and silver is when central banks look to sell it. For the first time in a long time, I have heard discussions about central banks beginning to sell gold again. So we could be approaching an opportunity to buy gold at advantageous prices.
If you recall, in 2010, 2011, and 2012, central banks bought gold. And that, of course, was the time to sell gold. We will continue to keep an eye on this story...
– Porter Stansberry
Porter on gold and silver...
In today's Digest Premium, Porter discusses the fundamental differences between gold and silver... And he offers his predictions on where the prices of the two precious metals are headed next...
To continue reading, scroll down or click here.