Here's a simple question, one that should be very easy for you to answer. Which asset, gold or the 500 largest stocks in the United States, would have been a better investment over the last 43 years?
The answer should obviously be equities. Everyone knows that, over the long term, nothing produces more wealth than owning America's best companies. And think about the enormous gains to productivity over the last 43 years... the improvements to health care... the massive investments into infrastructure and real estate. Surely the capital stock of America was a much better investment than gold. Surely the end of the cold war, the Reagan revolution, and the dawn of the personal computer all added tremendous value to the investments of Americans...
Nope. Stocks, as measured by both the S&P 500 and the Dow Jones Industrial Average, were actually worth more in 1966 in real terms than they were at the bottom of the market two weeks ago.
The chart below tells the story. The value of equities soared during the giant credit boom of the 1990s, rebounded significantly during the "echo bubble" of 2005-2007, and has now crashed back to levels seen as long ago as the peak of '66.
While your neighbors won't believe you, it's true. Adjusted for inflation, the capital stock of America is only worth as much today as it was 43 years ago. Gold, on the other hand, has gone from $35 per ounce to nearly $1,000.
Of course, stock investors have all felt rich at various times in the period – thanks to easy credit and paper money. But most of that easy credit ended up in what economists call "malinvestments"... things like three of the world's largest cities being built in deserts (Vegas, Dubai, Abu Dhabi)... things like vacant homes in America's ghetto being sold for more than $100,000 each... things like enormous (5,000 square foot) homes being built all across America's suburbs.
All of these things didn't increase our productivity at all. They weren't actually worth what they cost to build. And in a lot of cases, they're not really worth anything at all. But they consumed a huge amount of capital – money, commodities, labor, and energy. That's what most people don't understand about the dangers of paper money and easy credit. Sure, it's a great system to avoid anyone having to take responsibility for his mistakes. But all of the easy money leads to absurdity and waste. Real wealth, on the other hand, is only achieved through real savings and investments in productive assets.
The other danger of paper money? It concentrates all of the money and power in the hands of the central bank, which, of course, is controlled by the government. Today the federal budget accounts for nearly 30% of GDP – the most since WWII. Add in the highly regulated and highly subsidized health care industry and you've got the government in control of nearly half the economy. Now add in the banking system – which couldn't exist without the FDIC, which would already be insolvent without the backing of Congress. Now add in the insurance industry, which will surely collapse next (I explain why below). Now add in all the state governments' spending and employees.
Most Americans don't understand: The government is now running most of the economy, by a wide margin. And who keeps the government afloat? The Chinese.
Think about that for a little while... The so-called "Communist" Chinese, whose government makes up about 10% of China's GDP and who control the No. 1 freest city in the world (Hong Kong), are now paying for the most government-controlled economy in the world – the so-called "land of the free."
Speaking of malinvestment... I'm traveling to Las Vegas this weekend to attend the Casey Research conference at the Four Seasons. The last time I was there, I warned you about MGM and its giant construction project, City Center.
I cannot embellish on how big City Center is. Each of its six main buildings seems bigger than any existing building in Las Vegas. This is the largest privately financed development in the history of the United States. It sits in the middle of a desert, in a city whose economy is dominated by gambling. Those two facts alone would give most reasonable investors pause. The entire complex is five-star. One-bedroom condos here sold for $700,000. And the complex includes literally thousands of them. What will they be worth in foreclosure? I'd bet less than $200,000. And who will absorb those losses? I can't help but think in another two years we will look at those buildings and wonder, "What were they thinking? – PSIA July 2008
As it turned out, it didn't take two years for reality to set in. MGM's stock has continued to fall, from nearly $40 last summer to under $5 today. And the entire gambling sector is likely to go bankrupt. Says the WSJ:
The country's 18 largest casino companies are buckling under the weight of more than $65 billion in long-term debt. Casinos on average now owe $7 of debt for every dollar they project to earn. Some of the industry's high rollers such as Harrah's Entertainment and Las Vegas Sands owe $9 for every dollar of projected earnings. This is double the ratio of the last downturn in 2001 – and could be worse as earnings continue to fall faster than even worst-case projections... "I've never seen it so levered and I've been tracking it for 35 years," said Dennis Forst, KeyBanc Capital Markets Inc. gaming analyst who calculated the ratios.
And the problem is only getting worse. An estimated 17,000 additional hotel rooms are online, many from MGM's City Center. One analyst says there will be so many rooms, Vegas would need another airport to fill them all.
Speaking of more malinvestment... Mall vacancies are at a 10-year high. Huge retailers like Circuit City and Linens 'N Things have gone bankrupt. One advisory firm expects 200,000 more stores to close this year. And massive layoffs and record savings rates are only adding to the retail sector's problems.
In my latest issue of PSIA, I've compiled a list of 11 businesses that will fail. Six of them are commercial real estate firms. Shorting these 11 stocks will guarantee a great return for the year. To learn more about PSIA and access the "Losers List," click here...
You may recall a few weeks ago we received a very nasty e-mail from paid-up subscriber Richard, who accused us of spreading lies about the Federal Reserve.
We wrote, "So the Fed has aimed its printing press directly at the rea
l estate market. It will buy $500 billion of mortgages using freshly created dollars." Richard replied, "This is a lie... The Fed does not freshly create dollars... it borrows them, or collects them from people like you. You really need to fix this kind of rhetoric."
Few things are as exciting to us as being called liars... and it seems to happen quite a bit these days. So we hope ol' Richard was watching last night when our dear friend Uncle Ben Bernanke told Scott Pelley of 60 Minutes that he's been printing money as fast as he can – by the billions.
Bernanke: It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing.
Pelley: You've been printing money?
Bernanke: Well, effectively. And we need to do that, because our economy is very weak and inflation is very low. When the economy begins to recover, that will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.
You can read the full transcript and watch the video here.
We have a humble suggestion. We'd like to see everyone in America who thinks the value of our dollar ought to be sound and the government ought not to have the right to simply print as much of it as they want to gather at Baltimore's Inner Harbor. We could register our disgust and demonstrate what's happening to the value of our money by all dropping a $1 bill into the water. Call it a Tea Party if you want. Something must be done before Bernanke prints us into oblivion. America shouldn't run its finances like a banana republic.
When oil was at $150 a barrel, companies were paying up to $500,000 a day to rent drill rigs. Drillers couldn't keep up with demand. Transocean (RIG), the world's largest oil drilling company, had three year's worth of backlogged orders. Of course, this boom in demand led to a glut in drill-rig supply, which led to a glut in oil and gas supply. This happens during every oil cycle... The drillers flood the market with rigs. Then they pull too many rigs off market.
Now, with oil at $45, oil and gas drillers are idling rigs at the fastest pace since 2002. The number of rigs in the U.S. has fallen to 884 from a record 1,606 in September. Just as they overreact at market peaks, drillers overreact at bottoms. This drastic rig reduction will lead to a fall in supply, which will cause energy prices to soar (eventually). Click to view the historical North American rig count (courtesy of Baker Hughes).
Understanding the drilling cycle is the best way to speculate on oil because the drilling firms have great balance sheets (they'll survive) and, sooner or later, their stock prices will soar. The last time oil hit bottom, in 1998, these stocks saw a 10-fold move higher in less than a year.
I recently recommended an oil driller in Inside Strategist. Marty Whitman, one of the best value investors in the world, owns a slug of this stock. And one of the world's richest men is buying hand over fist. This company is currently trading for 25% of its net asset value. It's so cheap, I expect the share price will go up 10 times from here when oil rebounds. To learn more about Inside Strategist, which I'm currently writing, and receive my latest recommendation, click here...
Finally... a word of warning about your insurance company. Most people don't realize insurers own a majority of U.S. corporate debt. So as companies like MGM (whose bonds are trading around $0.30 on the dollar) fail and as the commercial real estate and retail sectors collapse, the values of the bond portfolios of the insurers are being wiped out.
Dan Ferris takes a careful look at the problem in his latest issue of Extreme Value, which is coming out today. From Dan:
Life insurance companies have been the biggest holders of corporate debt in the U.S. every year since the 1930s. People forget that life insurance companies can experience runs like banks, in which policyholders cash out en masse when they smell trouble. Like banks, there's also a fraudulent government insurance scheme to pay claims of insolvent companies. The 50 states' insurance guarantee funds total about $8 billion. They've paid out $21 billion the last 25 years...
Insurance firms don't mark to market as consistently as the banks, so the problem has been allowed to fester. That's too bad because four of them have already become penny stocks (GNW, PNX, AIG, and CNO). They won't be able to raise new equity.
Extreme Value subscribers will get the full story when we release his issue tonight. If you'd like to sign up for Extreme Value and access Dan's best bet for shorting the insurance industry, click here.
New highs: none.
In the mailbag... Taking a moment to say "thanks." We greatly appreciate the recognition. Lately, we feel like we've been toiling in vain. All of seven people ordered my Put Strategy Report, even after I showed you how 80% of my recommended puts made enormous profits over the last six months. Oh well. You can only lead the horse to water... Send your comments here: feedback@stansberryresearch.com.
"I have to take a moment and compliment you on your new service, Retirement Millionaire. I just read your 'Manifesto.' I think it's an ardent essay on the true state of affairs in our country. Thanks for the clear thinking. I expect to learn a lot and will read diligently." – Paid-up subscriber Joel Steinberger
"I know how much you prefer vigorous vitriol, or a political view that diverges from your own, or some crazy comment that boggles the mind. Sorry to disappoint you. All I want to say, and I want to say it loud and clear, is: Keep up the great work... Thank you for introducing us to the smart players in the industry that we would otherwise never have heard of. Thank you for pointing us to numerous sources of information that we would never have otherwise found. But most of all, thanks for constantly adapting your products and approach. Who else out there had the cojones to not only introduce readers to covered writing, but to the more arcane yet highly profitable areas of short selling and PUT writing (and buying)? So again: DONT STOP! Keep the ideas coming. Love you man.&qu
ot; – Paid-up subscriber R.K.
Porter comment: Put the booze down, R.K. (And thanks.)
"Your 3/13 Digest was just great. Not only the explanation of the Put Strategy (which I'm slowly catching onto) but also the responses to the mailbag. We are not living in the country I was brought up to believe existed. I was born in 1963, five months before JFK, and the more I study history the more I realize the country I was told I lived in hasn't existed since the 19th century." – Paid-up subscriber Henry Wesley
"Maybe you can explain to me why waterboarding is torture. From everything that I've seen, read and heard about it is that you feel like you're about to drown and it scares the pee out of you and you say whatever is necessary to get them to stop. But when it's over no one is even hurt, short term or long term. Just been scared. I've seen TV reporters put through it and when its over they stand up and walk away unhurt. My understanding of torture is maiming and hurting some one, either short term infliction of pain, or long term maiming i.e. John McCain. If I'm wrong explain to me how... Now, if other types of real torture were performed I've never seen nor heard of any proof other than terrorists, and tree hugging liberals, saying after they were released that they had been tortured while in custody. We all saw the photos from Iraq, but again, scaring someone with a dog or taking a nude photo doesn't seem like torture. Although I'll agree it was stupid and inappropriate. Does anyone actually have proof that someone's fingers were cut off, arms/legs broken, or their throats were cut by the CIA or U.S. military? P.S. I'll agree that all your readers need to be using your Put Strategy and Jeff Clarks Advanced Income. In 8 months I've made over $55,000 in an account of $290,000. Just today I made $40,000 for my father with a $75,600 possible investment for a stock he intends to buy in Sept." – Paid up subscriber JE
Porter comment: If waterboarding isn't torture, then why did we label it such during WWII? And why did we hang Japanese troops who had done it to captive U.S. soldiers? But besides these merely logical points, I find the entire premise of your question absurd...
Your argument is that nothing could constitute torture if it doesn't leave any lasting damage. If I shoved your head in a toilet repeatedly until you almost drown and made you terrified for your life every day of your captivity, that would certainly be barbaric behavior, but it wouldn't leave a scar. We cannot defeat terrorists by becoming terrorists ourselves. Also, if a captive will say anything to make water boarding stop, then how useful could it be? Finally, perhaps you think the Red Cross is just another "leftist" organization that wants to bring down America, but its report on the CIA's secret prisons clearly shows torture – several different types – was routinely used against the people we blackbagged around the world.
Of all the things the government has done over the years, I think the apparent torture of our detainees has done more to hurt our credibility and standing in the world than anything else. You can bet that from now on when Americans are captured or taken prisoner, they will receive the same in kind.
Regards,
Porter Stansberry
Baltimore, Maryland
March 16, 2009