S&A Digest: Merrill states the obvious: GM is going bankrupt

Merrill states the obvious: GM is going bankrupt... Signs of a top in commodities... It's not the leverage; it's the accounting... Who really owns your 401k?

It's officially bad out there. The Dow Jones Industrial Average saw its worst month since 2002 – down 10% – and its worst June since 1930. I sincerely hope you've followed our bear market warnings. If you're short a few stocks, selling covered calls on your core long-term holdings, holding some gold (or silver), and following your stop losses, you're probably doing a lot better than the market.

Merrill Lynch says GM will require $15 billion in cash to stay afloat. And "bankruptcy is not impossible." Longtime readers will recall we've been saying the same thing, much more directly, since January 2007. What's more interesting, though, was the speed of Merrill's change of heart. Up until this morning, the leading stockbroker in the United States had insisted GM's common stock was a "buy." Now suddenly, the price target is $7, the rating is "sell," and the company might file for bankruptcy. How can you explain this kind of ratings change? Let me show you...

GM's core problem is financial. In 19 of the last 20 years, it operated at a capital loss – meaning it didn't make enough money from operations to fund capital improvements, its dividend, and its interest payments. The result was an addiction to debt. Every year, GM had to borrow still more money. And guess who generated huge fees when GM had to raise more cash annually? Wall Street's banks, which brokered the bonds. Likewise, GM and GM's car dealers probably buy more advertising than any other group of companies in the country. So which media outlet was going to point out its death spiral? Just something to consider when you start to see bankers and media companies arguing for a bailout of GM. They'll be talking their own book.

Signs of a top in commodities...

You may finally be able to afford a Manhattan condo... New York apartment sales dropped the most in a second quarter since 1998 and unsold inventory is approaching an eight-year record. Sales fell 22% and inventory rose 31% to 6,869 units. But the median price of an apartment rose almost 15% to $1.03 million. If nobody's buying, the prices will eventually fall.

Don't blame the banks for erasing hundreds of billions in shareholder value by taking on stupid amounts of leverage and using the borrowed money to buy toxic loans in the middle of the biggest bull market in housing in our country's history. Who should we blame? The Federal Accounting Standards Board. Huh?

That's Blackstone Group founder Steve Schwarzman's argument. According to him, accounting rule FAS 157 is "accentuating and amplifying" losses. The rule requires financial companies to record the current value of the assets they own – a so-called "mark to market." That's a problem when you own subprime debt that no one will buy because the default rates on that kind of paper are soaring. But rather than face their real issue, the banks would prefer to change the rules, making it easier for them to hide their losses. No one in America wants to take responsibility for their actions or be forced to repay their debts. We've become a nation of moochers and welchers.

The answers to yesterday's trivia questions are lawyers and Goldman Sachs.

New high: U.S. Natural Gas Fund (UNG).

In the mailbag... A timely warning about the assets you think you own, but are actually controlled by the government. Send your best ideas here. We need all the help we can get: feedback@stansberryresearch.com.

"Many years ago, perhaps 10 or 15, I began to read that if our country ever got into a serious financial mess, that the IRAs and 401-Ks could be prime targets for the government to take (er, borrow) your money as these funds represent the largest available pool of money available 'for the picking'. Around the same time, an attorney in my office published an article in the Washington Post (I think) saying the same thing. Neither his article nor the information I was reading was well received. Everyone was angry at these authors who dared to suggest that the government of a democratic society would actually take what they considered to be 'their' personal money. Well, its not your money unless it is totally under your control without any restrictions, etc. IRAs and 401-Ks are subject to government rules and controls and they can change these rules at any time. Further, most Americans are not aware that there are laws on the books that allow the government to confiscate your money, whether in an IRA/401-K or not, if they deem the situation to warrant it. With all indications that we are headed for a depression far graver than The Great Depression, I suspect we may see this confiscation 'for the good of the country' come to pass." – Paid-up subscriber Ellen

"Just a note to let you know how much I appreciate your various publications that are in my Investment Library. I am a 28-year veteran in the securities industry. All as a Financial Advisor with major wirehouses. I have seen bull as well as bear markets. I read various research pieces each and every day. I always expect to make a long-term profit for my clients, but sometimes it just does not happen. I am always amused by the people that write you with lambasting critique because one or another of your various researchers provided information on an investment that provided a negative rate of return. As if profiting from every trade is a God-given right. It never happens quite the way we all want. The people that write these diatribes need to spend less time complaining and more time researching. You know, that 'old necessary stuff' like risk tolerance, time expectations, tighter stops if that arcane tool is useful and all the other issues that make an investor a better investor. I see you mention Mr. Buffett quite often. Can you imagine what his BH portfolio would like if he paid maximum attention to short-term swings? Keep up the wonderful work. You are appreciated more than you will ever know. The serious investors are so busy making money in the markets... well, we do not normally have the time to write and complain. Best wishes to you and yours." – Paid-up subscriber DAH

"I took your well considered and documented advice and prognosis and shorted Fannie and Freddie, and I am up a bunch. I believe that it is going to be a long play and I also believe it will be a very nasty end play. Perhaps an end play with the DOW at 8,500 from 'collateral damage'. After today's minus 350, there are some great prices on Verizon, Coke and many more of the solid ultimate survivors. But won't even these great defensive stocks be a lot cheaper in 6-12 months as F&F and the credit markets really get into free fall????" – Paid-up subscriber Fred Dexter

Porter comment: That's certainly a possibility. On the other hand, the highest-quality Dow stocks very rarely trade at such incredibly low multiples of earnings. Consider Verizon, which is the highest-quality telecom firm in the world. It is now trading for four times the cash it earns each year. And it's paying a totally safe 5% dividend. Could the share price fall more? Yes, anything is possible. But buying Verizon (and other super high-quality blue chips like it) at these prices is sure to earn you a high rate of return over any reasonable length of time. I don't believe you'll be able to perfectly time the bottom in this, or any other market. And you don't have to try. All you have to do to make a fortune in stocks is buy the best companies at good prices. You have that opportunity right now.

Regards,

Porter Stansberry

Baltimore, Maryland

July 2, 2008

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