S&A Digest: Uncle Sam: shareholder

Uncle Sam: shareholder... Politics and religion... Foreigners exiting the USD... Fight inflation: publish textbooks... How to think about sentiment...

 It is with some anxiety that I sit wondering what will happen when the Treasury starts buying Fannie and Freddie shares, as the new backstop plan says it may. Certainly its appetite for U.S. equity wouldn't stop there. How long will it be before the power mongers in Washington start buying up stakes in every major American financial institution?

Well, comrade, tell me. How long? Two years? One year? Six months? If you think corporate boards are bad now, wait until Uncle Sam shows up at the annual meeting.

 How far down your list of things to do with $52 million would we find the choice, "give it to Barack Obama"? Well, Obama raised $52 million in June. Can you imagine? Who is dumb enough to give money away to someone who promises to spend four years stealing from you?

American voters, that's who.

 Having made the mistake of commenting on politics, I'd feel only half-baked if I left out religion... On Thursday, Pope Benedict XVI said the world's natural resources are being squandered in the pursuit of "insatiable consumption." The Pope urged the faithful to care more for the environment and reconnect with the principle of peace. Reminds me of an old Police song...

Poets, priests and politicians

Have words to thank for their positions

Words that scream for your submission

And no-one's jamming their transmission

'Cause when their eloquence escapes you

Their logic ties you up and rapes you

As usual, I'm late to the party with this little song quote, since it's no longer shocking to accuse the Pope of rape... and even less so if you're talking about intellectual rape.

 You'll be happy you own gold and silver once you read this: "Sovereign wealth funds," foreign government investment pools, are dumping the dollar. One big fund in the Persian Gulf has cut its dollar-denominated holdings from more than 80% a year ago to less than 60%. China's State Administration of Foreign Exchange (SAFE) is working out deals with European private-equity funds to diversify away from the dollar. SAFE holds the majority of China's $1.6 trillion in foreign currency reserves in U.S. dollars.

 Foreigners also hold roughly $1.5 trillion in Fannie and Freddie AAA-rated debt. Merrill Lynch warned that the U.S. could face a foreign "financing crisis" within months as Fannie and Freddie unwind. And Merrill is certainly credible on the subject of financing crises, having caused more than its share of them...

Merrill has about 40,000 customers holding roughly $6 billion of securities called auction-rate preferred securities. Like all auction-rate securities, you can only sell them at auction, which occurs only once a month. These obviously illiquid instruments were successfully marketed as liquid, money-market instruments, which can be sold instantly at any time.

Market makers used to act as buyers of last resort if auctions didn't work well. But since auctions started failing earlier this year, the buyers of last resort have dried up and blown away. They don't want to get stuck with bad paper. They just want to stick others with it. Mutual funds that bought these securities as cash equivalents have a problem. They're unable to liquidate auction-rate securities to pay the large redemptions they all face in a bear market.

 We all know gold and silver are great to own during inflationary periods, but how about Google? Google raised the price of its online advertising 19% in the past year. And the worst-performing industries, mortgages and retail, are paying the highest prices. Google raised mortgage-company advertising rates 35% and retail rates 9.3%. Bloomberg expects Google shares to rise 25%.

 Or maybe you should get into the textbook business... SmartMoney's Anne Kadet reports, "Textbook prices have climbed 33 percent since 2003 – double the rate of inflation." I know a little about this. I've got nearly $300 invested in two accounting textbooks.

The Internet has led to an active market for used textbooks, causing demand for new books to soften. Publishers respond by putting out new editions at higher prices, knowing teachers will require students to buy them. Some students buy textbooks that have been smuggled into the U.S. from other countries. Considering the content of most textbooks, and the dismal, politicized college experience that awaits U.S. students, isn't that a bit like smuggling cow manure onto a cattle ranch?

 Guaranteed income for life... or rip-off? Annuities get a bad rap in the mainstream press, even though they're the only financial product (besides Social Security and pensions) that can guarantee you income for life.

We're doing research right now on several new annuity products. And we'd like to hear about your experiences – both buying and cashing them in. If you have benefited from an annuity, tell us about your experience: feedback@stansberryresearch.com.

 Goldsmith tells me it's a sign of a market bottom that short seller and permabear David Tice is selling his money-management firm to Federated Investors. Big transactions like this tend to mark tops and bottoms in the market. Recall Sam Zell selling his real estate portfolio in October 2007, and Blackstone going public at the peak of the private equity market.

I don't know, though... The S&P 500 is 21% off its October high of 1,576.09. And it's still selling for around 20 times earnings. Those earnings are almost certainly inflated, so who knows what it's really selling for? Twenty-two times? Twenty-five times? That might be fair value or overvalued, but it's nowhere near cheap.

 Until the market actually bottoms, my real job, as I see it, is to point out to you that many of the businesses investors are totally obsessed with these days – housing, mining, steel, oil & gas exploration, mortgage lending – are all highly cyclical and generally lousy businesses. Poor management and too much leverage are the rules in all of them. Paraphrasing Elmer Fudd, be vewy, vewy careful with them.

When there's a bear market on, that's when you're supposed to buy stuff like Wal-Mart, Western Union, H&R Block, ExxonMobil, American Express, W.R. Berkley, Dun & Bradstreet, and a bunch of other good stuff I've found lately in Extreme Value. Porter has a similar list in PSIA.

 New highs: none.

 If you've smuggled a textbook lately, please tell us about it here: feedback@stansberryresearch.com.

 All the mail is about Porter's speech at FreedomFest last week, so I thought I'd let him deal with it, if he wants to. I was there, but I didn't see the whole speech.

I wasn't really shocked by the language he used in the bit I did see. I'm more shocked dozens and dozens of people aren't shouting at the top of their lungs about what's going on in the United States. We aren't a polite society to begin with. Why are we so polite to those who think kidnapping and killing us while stealing our money and property is a legitimate way to make a living?

Regards,

Dan Ferris

Medford, Oregon

July 17, 2008

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