The rally in stocks since early March included a bunch of garbage. I have a spreadsheet of about 400 companies with more than $100 million in market capitalization that are overleveraged, unable to refinance, and unable to meet their debt-service payments from earnings. They're like lit matches. It's only a matter of time until they burn out.
You've seen me write about many of these stocks over the past six months – General Growth, Macerich, MGM, etc. But since March, nearly all of these stocks have posted huge gains. Many subscribers, I'm sure, thought that meant my analysis was wrong. Nope. The stock market is a fickle beast... and it's never easy to make money on any trade – even when all of the facts and the circumstances are lined up in your favor.
What's happened with shorting these overleveraged companies is that too many people put too much money on the short side. When a position gets that unbalanced, it's sure to "snap back." In fact, over the last six weeks, companies with the most debt and the lowest returns on assets turned in their best six-week performances since 1938. Says Bloomberg: "The 130 companies in the S&P 500 and Europe's Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero... rose an average of 82 percent from March 9 through April 17."
So the worst companies' stocks did about four times better than average during this rally. Meanwhile, nothing improved with the fundamentals of these businesses, most of which remain deeply troubled. How do you explain the worst stocks doing so much better than average? A short squeeze. The speculators holding these heavily shorted stocks were forced to cover. Reports coming from momentum hedge funds suggest their first-quarter losses were significant.
Let's look at one situation in particular – Macerich, the mall owner whose competitor, General Growth Properties, recently filed for bankruptcy. Macerich owes $6.7 billion in debt – mostly in the form of mortgages on its malls. It acquired most of its portfolio in 2002-2006, when real estate was extremely expensive relative to rents. (Macerich spent $2.3 billion for the mall owner Wilmorite Properties in late 2004; it bought another mall owner, Westcor, for $1.5 billion in 2002.)
But now mall vacancies are soaring. According to mall research firm Reis, retail tenants vacated 8.7 million square feet of space in the first quarter of this year, on top of the 8.6 million square feet vacated in all of 2008. Mall vacancy rates are now nearly 10% – a record increase from last year. Given the current market, Macerich won't be able to sell property for anything like the prices it paid. Assuming it could get 50 cents on the dollar, its asset base isn't worth the $6.3 billion it claims on its balance sheet. It's probably worth more like $3.1 billion. And that means it can't sell enough property to pay down its debts.
And that's not the worst part. The real problem is Macerich can't afford the interest on its debts. The analysis is simple: Macerich takes in rents. It pays for its overhead, its interest, and the upkeep in its buildings. It brought in $537 million in rent during 2008. It spent $16.6 million on overhead and $277 million on upkeep. That left $243 million for interest. But interest expense was $281 million.
My bet is the great garbage rally of 2009 is finished. While I expect high-quality companies with good businesses to continue to do well, I don't expect companies like Macerich or any of the other overleveraged companies to make it out of this recession. They're going bankrupt. It's only a matter of time.
Bank of America today announced earnings of $4.25 billion for the first quarter – more than it made in all of 2008. Mmmn... Where did the money come from?
Well, $1.9 billion in net income came from the sale of China Construction Bank (CCB) shares. And $2.2 billion came from marking up Merrill's book of mortgages. If you subtract these one-time gains and special accounting adjustments, Bank of America actually lost $1.3 billion.
It has always seemed strange to me that public investors put up with all of the accounting nonsense that goes on in public companies. I'd never own a stock whose CEO couldn't tell me in plain English whether or not the company had made or lost money. I mean, Warren Buffett, who controls an enormous holding company and some of the world's largest and most complex insurance companies, somehow manages to explain what's happening each year using plain English and remarkably few numbers – all of which are simple and intuitive. Why can't everyone else?
Here's what Bank of America (and the government) don't want you to know: Credit quality deteriorated across all of its businesses and loan portfolios. Nonperforming assets increased to $25.7 billion from $18.2 billion last quarter and $7.8 billion year over year. To protect itself from future losses, the bank increased its provision for credit losses to $13.4 billion from $8.5 billion, including a $6.4 billion net addition for loan and lease losses.
New high: Vanguard Short-Term Tax Exempt fund (VWSTX).
In the mailbag... a short lesson on accounting. A subscriber who made his escape. And two great thinkers on global warming. Send us your thoughts. Or pillory ours. feedback@stansberryresearch.com.
"I often hear you refer to solid company's which have 'free cash flow' (for example, your comments on Microsoft in talking about its free cash flow in relation to enterprise value), but what exactly is the difference between a company's 'free cash flow' and the 'net profit' reported in its profit and loss/cashflow statement?" – Paid-up subscriber Nayem
Porter comment: Net income is a product of the income statement. Of the three financial statements (income, balance, cash flow), the income statement is the most fictional. It contains lots of estimates and all kinds of rules dictate what numbers you're allowed to put on your income statement. Why investors pay any attention to the income statement is a mystery to me. They shouldn't call it the "income statement;" they should call it the "sucker's statement." Or the "bamboozle statement."
The cash-flow statement, on the other hand, is wha
t's used to reconcile the income statement to the balance sheet. It's an accurate reflection of how much cash the corporation took in and where it all went. Plus it includes all of the expenses the income statement conveniently ignores – like major capital improvements, investments, etc. In my mind, the real way to value a business is to see how much money is left for the owner, on average, through a complete business cycle – say, 10 years. To do that, you have to count all expenses (not just the ones the CEO wants to tell you about).
"I bought property in the western Caribbean nation of Belize in 1998 and constructed a house there as well. They have a 'Retired persons incentive program' which is quite attractive. They do NOT tax my US income; they have internationally recognized accounting firms which assist you in setting up your investments, buying and managing businesses, etc. It is a peaceful, English-speaking nation. As of this date, they have not begun to 'raid' the gringos/ex-pats money and I am certain they will not as they know, we'll just leave. Our congressman lives nearby. We know his children, we know how to reach him and complain to him. There's only about 300K people in the entire state. I went there to live on the beach in a place I could afford and that acted like it appreciated me being there. It's 2 hours from Houston on Continental. Come on down, the weather is fine and the taxes are non-existent (my property tax on my beachfront home was $14.77 BZD this year). I still live 6 months per year in the USA. This will be my escape route if BO really starts to stink the place up." – Anonymous
Porter comment: Do you have a Belizean passport? Can you travel to most places in the world without a visa? Can you travel from Belize without going through the U.S.?
"You remind me of the debate when I was growing up and you weren't even a gleam in your father's eye about whether a 'curve ball' was 'real' or 'an optical illusion.' Those who understood physical principles argued that a 'curve ball' was 'real.' Those who confused people with jargon argued the other side. Same with 'global warming' (a poor term, but an accurate description of the mechanics of 'greenhouse gases'). The scientists who understand cause and effect, understand that energy reflection causes temperature buildup. They also understand that temperature buildup causes pattern changes in airflow and sea-current flow. This, in turn, leads to temperature decreases in certain areas. The combination of heat buildup in some areas and temperature decreases in others, is what should be properly covered by the term 'climate change.'
"Those who look only at 'trends' and say that what happened tens of thousands of years ago over thousands of years of change tend to argue that there's nothing different if 10,000 years of history are condensed into several hundred. They too cannot see the curve ball – or argue that it is an optical illusion. Those who say that the amount of carbon dioxide in the air is the same, independent of the actions of humans on this planet seem to have forgotten that it is plants and trees that take CO2 in, and release O2 in its place.
"If humans cut down the rain forests, how is that humans have not altered the absorption rate of carbon, and the release of oxygen back into the atmosphere? If humans put CO2 into the atmosphere (through cars or power plants or other means), how is it that humans are not responsible for the increase of CO2 in the environment? No self-respecting scientist argues that humans have no impact on their environment. That is left to 'shills' for the energy industry. And you, O-PAWTUH!, admit to being taken in by them! How amazing! Are your economic analyses as bad as your scientific ones? Is that why I've lost more money on your recommendations than anyone else's... Are you as inadequate an economist as you are a scientist? Would you like to give me back my Private Wealth Alliance investment so that I would go away and not expose your incompetence? At this point, I'm willing to take it, and disappear forever. Just say the word!" – Paid-up subscriber James Wood
Porter comment: This is one of my favorite things about the global warming mafia... If you raise any legitimate questions about the absurdity of their claims, they immediately attack you personally. They point to all kinds of issues completely beyond the realm of the global warming issue (like the physics of curveballs or their investment losses).
While thousands of scientists can argue intelligently that global warming either isn't real or isn't a problem or isn't manmade, my very favorite is Freeman Dyson. He is not only a "real" scientist; he's been one of the most respected scientists in America for more than 50 years. He worked with Einstein. He was friends and colleagues with Feynman. He has been ensconced at the Institute for Advanced Study since 1957. And he says Global Warming is nonsense.
The other articulate and well-educated person I've heard addressing these issues sensibly is Michael Crichton. While not a working scientist, Crichton spent his entire life thinking about scientific problems and writing about them in his novels. If you're not familiar with his several speeches about global warming, they're both insightful and very funny. Here's Crichton talking to Charlie Rose.
Regards,
Porter Stansberry
Baltimore, Maryland
April 20, 2009