I must be a typical value investor. Everywhere I look I see another bubble bursting and a new one forming. For example, the government doesn't seem satisfied with the first subprime bubble. It's on its way to creating another one...
Remember back in 1992, when the government forced Fannie Mae and Freddie Mac to buy subprime mortgage loans under the guise of encouraging the development of "affordable housing"? That subprime bubble formed in the early to mid-'00s and popped in 2007... with the rest of the financial world melting down the following year. Today, Fannie and Freddie are essentially bankrupt, on government life support.
That was so much fun, the feds are doing it again. This time, the Federal Housing Administration (FHA) has taken over where Fannie and Freddie left off. The FHA is the U.S. government's original subprime lender (via guarantees on subprime loans). And the FHA today is in high gear. It now accounts for 60% of all purchase mortgage originations, roughly $1 trillion a year (and rising fast) in subprime loans.
At the height of the first subprime bubble, about 40% of mortgage loans were made with down payments of 5% or less. Today, due to the FHA's massive takeover of the subprime mortgage space, about 60% of all mortgage loans have been made with down payments of 5% or less.
The FHA doesn't care about all the new garbage loans it's guaranteeing, either. It has the pedal to the metal. By 2013, the FHA says it'll insure a total of more than $1.3 trillion in loans. Not all FHA loans are subprime, but it's working on that, too... The FHA recently announced nearly half its purchase volume will be subprime by 2017. Taxpayers, beware. You'll wind up paying for the enormous losses all this new subprime lending will create.
On top of the new subprime lending the FHA is shoving down our throats, there's the fact that we won't need to build another new house in this country for a few years.
The most recent numbers on the national housing supply are from August 2010 (the end of the peak buying season). At that time, more than 4.2 million homes were on the market in the U.S. But... another 2.1 million homes were in the "shadow supply" – homes in some state of delinquency or foreclosure that are unaccounted for by conventional methods.
So with more than 6 million homes in inventory... why would anyone go long a housing stock, except as some kind of very short-term speculation? How long would it take the top 20 U.S. homebuilders to build 6.2 million homes? Because that's how long those companies will appear to be completely redundant.
Yes, I know housing is a regional industry. I know a local builder here who has built and sold a few smaller homes recently. But really... where in the country is there a true housing shortage, except in cities with rent controls (where housing is in perennially short supply)? Nowhere. There's a giant surplus of literally millions of new homes for sale or in some state of foreclosure.
In the latest Stansberry's Investment Advisory, Porter and Braden are shorting a housing stock. Porter calls it "your best bet for a sure thing."
On September 10, 2010, we wrote a Digest titled "A Serious Warning About Muni Bonds." We noted Harrisburg, Pennsylvania's inability to repay part ($3.29 million) of the $288 million it borrowed to buy an incinerator. Mayor Linda Thompson said she didn't pay because "to disrupt our services because we can't make a bond payment would just be unconscionable. And as a leader, I couldn't do it." According to Thompson, a state's debts are optional. It's a scary thought that billions of dollars of municipal debt can go unpaid simply because the borrower doesn't want to pay. We drew the following conclusion:
When our elected officials no longer care about repaying hundreds of millions of dollars, the entire system of municipal finance is going to collapse.
If you had heeded our warning and shorted munis then, you would have already produced a tidy profit. As you can see in the following chart of the iShares S&P National Municipal Bond ETF, munis have gone straight down.
But the problem is only getting worse. Just look at Illinois...
Illinois is trying to solve its $13 billion budget deficit this week (years in the making... days to solve). The deficit includes more than $6 billion in unpaid bills – again, states can apparently choose when and which debts to repay – and $4 billion in missed pension payments. Illinois' deficit totals around half its $26 billion budget. Not only is the deficit growing, it's also becoming more expensive to finance. Illinois and California share Moody's lowest credit rating among U.S. states. But Illinois also has a "negative outlook" from the rating agency.
The cost of insuring Illinois debt rose to a five-month high last week... Insuring $10 million of Illinois debt against default cost $350,000 a year on December 29... more than California's $298,000.
How does Illinois plan on fixing this deficit? Of course, it's considering increasing the state income tax to 4% from 3%. It's also considering expanding gambling. (On a side note, I love that our nation's big solution for the budget deficit is gambling.)
However you look at it, Illinois is out of options. James Nowlan, a former member of the state House and now a senior fellow at the University of Illinois Institute of Government and Public Affairs, put it best: "I think they're finally educated that all the one-time adjustments and shenanigans have been pulled, and they are now facing the fiscal abyss... But maybe I'm too hopeful."
Illinois's situation is so bad even Bill Gross isn't buying its bonds. You may recall Gross recently added $4.4 million of his personal wealth into five PIMCO municipal bond funds. The investment nearly doubled Gross' personal position in munis to around $8.9 million. It's a small investment for Gross (his estimated net worth is $2.1 billion), but still a show of confidence.
Regardless, he's not touching Illinois. Gross recently said on CNBC, "Illinois is probably in the worst shape." It's worth noting when one of the world's best bond investors announces on television that he's avoiding Illinois municipal bonds, while loading up on others. For the record, we would avoid all municipal bonds today. We think Gross is early.
We're not the only ones betting on inflation, either... Warren Buffett's Berkshire Hathaway recently sold $1.5 billion in fixed-rate debt to retire the same amount in floating-rate debt. Buffett has loaded up on hard-asset businesses in the past few years. Berkshire Hathaway now gets 50% of its revenue from four noninsurance, asset-based businesses: McLean (retail distribution), Burlington Northern (freight railroad), MidAmerican Energy (domestic and foreign utility), and Marmon (diversified industrial products).
And now Buffett is making another obvious inflation-oriented bet... He just sold $1.5 billion of mostly fixed-rate bonds and retired the same amount of variable-rate debt. The obvious conclusion is the correct one: Warren Buffett obviously expects interest rates to go up.
Is another Internet bubble forming?
One price has certainly inflated substantially in recent months: The valuation of Facebook, the privately held social networking site. About five months ago, shares of Facebook changed hands privately at prices suggesting a valuation of more than $26 billion. A recent Goldman Sachs investment in Facebook suggests a valuation of $50 billion.
And Facebook isn't the only one. Overall, from June 30 through the end of December 2010, the valuations of the top 11 private Internet companies rose 54%, compared with a 19% gain in the S&P 500 Media Index, according to private market tracker Nyppex. Twitter's value more than doubled to nearly $4 billion during the second half of 2010. Groupon's value more than tripled to $4.8 billion when Google started talking about buying it in November.
New highs: Almaden Minerals (AAU), Cenovus Energy (CVE), WidsomTree SmallCap Japan Dividend (DFJ), First Trust Dow Jones Select (FDM), Northern Dynasty (NAK), Suncor (SU), Automatic Data Processing (ADP), Arch Coal (ACI), Markel (MKL), Fuel Tech (FTEK), ConocoPhillips (COP), ExxonMobil (XOM), Vanguard Natural Resources (VNR), North America Energy Partner (NOA), SVB Financial (SIVB), U.S. Ecology (ECOL), Alexander & Baldwin (ALEX).
In today's mailbag... a couple subscribers describe how our advice worked for them. How did we serve you last year? Send your e-mail to feedback@stansberryresearch.com.
"First I want to thank you for many of your recommendations in 2010. I may not have always picked your specific stock but did activate your recommendation with like stocks. I am up over 80% in silver using both buying SLW and buying and selling call. I also invested in other small silver stocks. Gold was also very good to me along with coal companies in both Canada and China. Yield for the year 55%. From $360,000 to over $562000. This is my first full year investing on my own with out a broker. It goes to prove with good information anyone can ply the market." – Paid-up subscriber Don Campbell
"At the beginning of 2010, I tried to position myself so that by following your advice, (trail stops, etc.) I would hope to make a modest amount of money. And with the picks from Matt Badiali, I made a 250% return on my investments. Plus, buying gold and silver at coin shows during the year, also showed a big gain. So this year, hopefully, more of the same! Thank you Stansberry and Associates." – Paid-up subscriber Gary
Ferris comment: I'm happy to see readers taking action and profiting from those actions. As for what will work in 2011... I don't know. But I bet 2011's best-performing investments will be different than 2010's.
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
January 4, 2011