A recent debate among S&A editors explored the question: inflation or deflation?
I doubt it's that simple. Mass destruction of bank collateral certainly reduces lending capacity. Since our banking system is where the bulk of our money is created, deflation seems a rational expectation...
Except that the redwood seeds in the money-creation forest – excess bank reserves – have grown approximately 4,500% lately, to around $900 billion. Multiply those reserves by 30 or so, as the banking system would over time, and you get more than double the entire GDP of the United States.
But as long as the banking/lending apparatus is broken, it's hard for the system to multiply new money into existence via loans and deposits.
Meanwhile, everything I buy in my daily life is more expensive now than several months ago. All my utilities have gone up over the past year. I pay more for gasoline than I did several months ago. Price tags on the piles and piles of snacks my three athletically inclined teenagers require have risen anywhere from 10% to 50%.
I've made recommendations that will benefit from the further destruction of bank collateral, as well as recommendations that will do well when gold and other commodities rise, which is what we expect to happen during inflation. This is an unforgiving environment. You can't afford to be too doctrinaire or simple-minded.
So let's first look at the destruction of bank collateral...
Troubled western regional bank Zions Bancorporation posted better-than-expected results, but Mr. Market didn't buy it. The stock tanked 10%-11% this morning. Zions is a bank holding company that owns eight banks. Four of those banks have seen losses eat up more than half their loss-absorption capability. Zions now has $1.9 billion worth of nonperforming assets, up from $1.77 billion last quarter. Zions, like other regional banks, made too many risky commercial real estate and construction loans.
Zions isn't the only one suffering. Morgan Stanley's $18 billion worth of commercial real estate exposure is one of the main reasons the larger bank is expected to post a $500+ million loss. One project, the Revel Casino in Atlantic City, needs $700 million in financing before it can continue.
Starwood-owned St. Regis and its lender, Citigroup, are also among recent commercial real estate casualties. Citi made a $70 million loan to the St. Regis Monarch Beach Resort in Dana Point, California. St. Regis can't repay it, so Citi has taken the hotel back.
The resort was in the news last fall, when it held an AIG meeting for top salespeople right after AIG had received its first government bailout payments. The public outrage caused several financial-services companies to cancel events at the resort. The government giveth and the government taketh away.
Credit-card lender Advanta Corp says its default rate more than doubled from May to June and is at 56.95%... five and a half times the industry record default rate of 10.4%, set in June. Advanta cut off a million small-business accounts after posting three quarterly losses in a row. The FDIC told Advanta to submit a plan to repay depositors in full, a process that'll take years.
So much for the destruction of bank collateral. Now, let's look at the effects of inflation...
We wrote it, did you buy it?
First, we noticed the insiders at Valhi (NYSE: VHI) are buying the stock heavily. Valhi is a tightly held holding company whose majority owner, Harold Simmons, is a legendary value investor. Simmons bought more than 10,000 shares of the stock last month. Vice Chairman Glenn Simmons also bought more than 10,000 shares.
It has been our experience that when these insiders buy, it's time to be long Valhi. If you missed the big run we got in the stock between 2004 and 2006, now is your chance to buy. – July 2009 issue of Porter Stansberry's Investment Advisory
At the time of Porter's Valhi update, the stock was trading at $6.14... Since then, shares have skyrocketed to $11.92 – a 94% gain in six trading days...
And Porter's most recent recommendation, Boston Scientific (BSX), announced earnings last night... The medical-device manufacturer saw earnings increase 61% from a year earlier – on its way to its first annual profit since 2005. Since then, Boston Scientific has been writing off profits due to its pricey acquisition of defibrillator maker Guidant. Sales of stents and defibrillators – its two core products – jumped 10% and 8%, respectively.
Continental Airlines also announced earnings, but the situation is much grimmer... The company's quarterly loss widened to $213 million from $5 million a year ago, and revenue dropped 22.7% to $3.1 billion.
Continental said business travelers cut back on travel and/or bought cheaper tickets. Also, swine flu cost the airline $50 million in lost revenue for the quarter. Though reduced demand and price competition seem to support the deflation case we mentioned above, fuel prices are hurting Continental, and that's not likely to change anytime soon.
The airline will cut 1,700 jobs, in addition to the 500 previously cut positions and 700 flight attendants to whom Continental offered leave.
The company also raised its luggage fee by $5 and increased its telephone reservation charge by $5. Continental hopes the new measures will generate $100 million in annual revenue when they are fully implemented in 2010... if the company makes it that long. Shares fell over 7% on the news.
Doc Eifrig has found a way to profit on inflation no matter how long it takes to show up... It's an unusual government-backed silver investment. It turns out, you can buy real, hold-in-your-hand silver for as little as $1.25. To learn more, click here...
New highs: Hatteras (HTS), Crucell (CRXL), Addax Petroleum (AXC.TO).
What's your take on inflation versus deflation? Let us know here: feedback@stansberryresearch.com.
"If MetLife does have to write off its commercial real estate loans, as reported in the 7/9 and 7/13 S&A Digest, I can understand shorting MetLife, but what about its annuity holders? How might this write down impact their annuities, or even their life and health insurance policyholders? For MetLife Target Maturity annuity holders, would you recommend surrendering the annuity and taking the 7% surrender charge, or would these annuities be protected or guaranteed against such a huge write down?" – Paid-up subscriber Bob
Ferris comment: The answer to your question would be a big, fat guess on my part, so I'll refrain. Regarding MetLife overall, I've said a couple of times before that I don't expect it to fail.
I merely expect the entire life insurance industry – MetLife included – to wake up one day soon short of regulatory capital and having to raise more equity, which would dilute current shareholders.
If it impaired its $36 billion commercial mortgage portfolio just 5%, it would eat a 10% hole in tangible equity. A 20% impairment would wipe out half of MetLife's tangible equity. I don't pull 20% out of thin air, either. That's the reduction in fair value of MetLife's commercial mortgage-backed securities portfolio. The commercial mortgages are currently carried at 99.7% of cost.
"I agree with you that once the government taxes go over 50% there is a huge drop in work incentive and moral. At that point I will just invest long term in high dividend paying, tax sheltered investments, play golf and forget the 10-12 hour a day grind to make money for the government master. I will also travel more and look for a better country to live and prosper in." – Paid-up subscriber Pete Ewing
"The paid up subscriber David G should be refunded his money and banned from your customer list. He has definitely been drinking too much kool aid." – Paid-up subscriber Roger H.
"Whenever anyone tells me taxes are good and necessary, I point out that all taxes are based on the idea that VIOLENCE is acceptable, or even desirable. All taxes are collected under a threat of violence if you don't pay. Try to keep your money, and thugs with guns will eventually come to take it from you with whatever level of violence is necessary to get it. Liberals/progressives/Marxists genuinely dislike violence, so this argument hits them in a vulnerable spot. They are extremely closed-minded, as you can tell from your correspondence. But pointing out the violence will get through to a few. This argument is what swayed me, a former lefty. When I made the connection that as a leftist I was advocating violence, I re-thought the whole thing and realized I was really a Libertarian." – Anonymous
Ferris comment: It sounds like you figured out that government comes out of the barrel of a gun. I disagree, though, that "liberals/progressives/Marxists genuinely dislike violence." They merely dislike admitting they're in love with it. Otherwise, many of them would be where you are now.
"I owned a one-man insurance agency in California. I asked my accountant why I showed I was earning such good money but never seemed to have it in the bank. He told me that between Fed, State, Municipal and both side of FICA payments I was left with 49% from a one man business! That's when I decided I had enough." – Anonymous
Ferris comment: The idiots took more than half what you alone earned and still have a $26 billion budget deficit. The People's Republic of California is an unmitigated disaster.
Regards,
Dan Ferris
Medford, Oregon
July 21, 2009