Thu, Aug 15, 2013|Sean Goldsmith

The only number to watch today...

The type of people I trust least...

In today's Digest Premium, Porter takes a final look at Bill Ackman... why the hedge-fund manager's public persona is untrustworthy... and why his actions lead Porter to never want to invest with Ackman.

To subscribe to Digest Premium and access today's analysis, click here.

Today, we continue our discussion of hedge-fund manager Bill Ackman. As I said yesterday, I don't appreciate Ackman's hypocrisy surrounding his short sale of supplement company Herbalife.

And deservedly... his mistake has cost his hedge fund around $600 million so far.

Let me be very clear. I wouldn't invest in Herbalife, because I personally find multilevel marketing distasteful. It's just not for me. But that's a huge step away from calling the people involved criminals. I don't know of anyone involved in Herbalife who is a criminal. I just don't want to participate in its business model.

But there's another hypocrisy surrounding Ackman's Herbalife short... Ackman unveiled his short thesis at a public meeting in New York City. The live presentation was simulcast on the web and his slideshow was also posted. It was an incredibly public takedown.

Then, Ackman has the gall to accuse George Soros, who recently went long Herbalife, of insider trading... He said the fund manager had told other hedge-fund managers he was going to go long before doing so.

I've already shared my thoughts on insider trading... I think the rules are flimflam nonsense. I cannot imagine why Soros telling anyone anything about Herbalife could constitute insider trading. Soros is not on the company's board. Soros is not a fiduciary of Herbalife. Soros should be able to say whatever he wants about the company. It shouldn't be anyone else's business.

– Porter Stansberry with Sean Goldsmith

The type of people I trust least...

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The only number to watch today... Bullish news... Why a good economy doesn't mean higher stock prices... How interest rates affect stocks... Dan on Wal-Mart's earnings... Paulson dumping gold...

You only need to focus on one number today...

And that's the 10-year U.S. Treasury yield. The benchmark yield rose eight basis points (0.08%) to 2.79% today – the highest since August 2011. Yields have risen nearly 120 basis points (1.2%) in the past three months.

We've long warned we'd see an increase in interest rates (which until recently were at record lows thanks to interference from the Federal Reserve). And it's happening...

Investors are selling out of bonds today (pushing yields higher) as they become more bullish on the economy.

And they have plenty of things to be bullish about...

Homebuilder confidence, as measured by the National Association of Home Builders, hit a nearly eight-year high. Low housing supply pushed the index to 59 in August (a reading above 50 is bullish) – it was the fourth consecutive monthly gain.

And initial jobless claims fell to 320,000 from 335,000 last month. That beat expectations. And it's the best number since late 2007.

Still, stocks are in the red. If investors are bullish on the economy, why are stocks selling off?

Well, a growing economy isn't necessarily good for stocks... It sounds counterintuitive, but stick with us.

Steve Sjuggerud debunked this fallacy in the February 25 DailyWealth. He wrote...

The simple, innocent lie goes something like this: "Well... the economy is doing better, so the stock market should do better, too."

Sounds believable. But it is simply not correct!

The truth is, to make the biggest gains going forward, you want to buy into a "bad" economy – one where economic growth is zero or lower.

He also provided this table showing quarterly data for U.S. economic growth back to 1947...

	GDP Below 0%	GDP Above 6%	Buy & Hold
One-Year Return	18.5%	4.2%	7.3%
Time in Trade	13%	14%	100%
None of today's numbers include dividends.

Steve concluded:

Since 1947, simply buying and holding stocks would have earned you a 7.3% compound annual gain.

But when the economic times are great – when the economy has grown at 6% a year or faster over the preceding four quarters – stocks have delivered a compound annual gain of 4.2% over the next 12 months.

Meanwhile, when the economy has contracted over the preceding four quarters, stocks have delivered an astounding 18.5% compound annual gain over the next 12 months.

A growing economy means higher earnings for companies. But that doesn't necessarily translate into higher stock prices.

That's because interest rates influence what people will pay for stocks. They're a critical factor determining the earnings multiple for stocks.

Bonds are generally less risky than stocks. As bond yields rise, stocks become less attractive.

Today, money in a savings account earns nothing. And 10-year Treasurys (the so-called "risk-free" rate), while up from the bottom, still pay less than 3%. That's why today, stocks are relatively attractive.

But imagine if you could earn 5% in your savings account... Would you still be rushing out to buy stocks?

So as interest rates rise, the earnings multiple for stocks contracts.

Interest rates could easily double from today's rates in a short period of time. But even assuming an improving economy, earnings would improve much slower. They wouldn't double overnight.

That means the multiple investors would pay for stocks falls, resulting in lower stock prices.

As Porter wrote in the August 2 Digest Premium...

I'm convinced interest rates are going higher. And that will cause a lot of companies to report lower earnings in the future. More important, it will put pressure on the market "multiple." In other words, stocks are trading at 16-18 times earnings right now. In an environment with rates at 4% or 5%, you'll see stocks trade at 12-14 times earnings. So if earnings fall... and the market places less value on earnings... that will have a huge impact on stocks...

We're not saying interest rates are going to soar tomorrow... But it's an important concept to understand. It has more effect on your stock portfolio than you probably realize.

For more signs of an improving economy, check out today's DailyWealth, written by Dr. David "Doc" Eifrig. Doc notes the economy is indeed improving, as evidenced by consumer comfort, manufacturing, and other indicators. And he believes that's bullish for stocks.

A growing economy, in itself, can be bullish for stocks. The key is what interest rates do. And Doc acknowledges this, saying:

The American economy will continue "grinding" higher. We're not headed into a recession... And we have yet to see inflation.

The inflation Doc mentions would coincide with higher interest rates. And as we explained, higher interest rates mean lower stock multiples. So as long as interest rates remain low, stocks could march higher.

The world's largest retailer, Wal-Mart, announced earnings that disappointed Wall Street today.

Earnings rose from $4.02 billion in the second quarter of 2012 to $4.07 billion today. Revenue increased 2.3% to $116.95 billion.

And sales at U.S. stores that have been open at least a year, a key retail metric, fell 0.3% – the fifth consecutive decline.

Wal-Mart also lowered its full-year earnings guidance by $0.10 a share to between $5.10 and $5.30. The stock dropped nearly 2.5% on the news.

I asked Dan Ferris, who holds Wal-Mart as a "World Dominator" in the model portfolio of his Extreme Value advisory, for his take on Wal-Mart's earnings. In short, he's not worried...

I'm trying to find the disaster in the actual numbers... but it's not there.

Sales last quarter were up 2.8%. Wal-Mart International sales grew 4.4%.

Earnings per share grew 5.1%. Wal-Mart's U.S. operating income grew 5.2%, and operating income (not counting fuel costs) from its Sam's Club division grew 8%.

Wal-Mart earned a return on investment of 17.9% for the 12 months ended July 31 (the end of the fiscal second quarter).

Free cash flow was down about 10%, to $5.2 billion compared with $6.1 billion in the first half of last year. That doesn't bother me. Everybody knows Wal-Mart performs better in the second half of the year. Also... it's one six-month period. One six-month period is not the end of the world.

Wal-Mart says it'll earn $5.10-$5.30 per share... instead of its previous guidance of $5.20-$5.40 per share. Again, not a disaster.

Instead, Dan says investors should ignore the market noise and focus on the long term...

If you're the kind of person who wants to feel bad about every little tick of data, Wal-Mart's results look really bad. If you're in the business of reacting to every new report and having a bunch of stuff to say about it (like CNBC and every other news outlet), you'll do what they always do... look at the stock price, assume the market is smart (it's NOT) and adjust your commentary accordingly. What a farce. I promise you, if you gathered up the combined knowledge of all CNBC talking heads and laid it end to end, it wouldn't make it out your front door.

And if you're a doom-and-gloomer, you have to be highly selective these days about the data you'll acknowledge. For example, consumer confidence is rising. Auto lending rose $20 billion in the second quarter, the biggest rise in seven years. Total consumer debt fell by $78 billion, to $11.2 trillion, the lowest level since 2006. So maybe retailers like Macy's, Kohl's, and even Wal-Mart are selling less furniture and clothing as Americans buy new cars with the 6% increase in inflation-adjusted income they've received since the 2009 recession ended.

Most people think every new data point is the beginning of a new trend... despite the fact it almost never turns out that way.

Human beings make it so easy for other human beings to get a huge advantage over them in the stock market. All you have to do is be reasonable and patient, and you're way ahead of 99.9% of all stock market participants.

All of the large hedge funds are filing their quarterly reports disclosing their positions to the Securities and Exchange Commission... And we'll discuss the actions of a few, key hedge-fund managers tomorrow. But I did want to share one quick observation...

Billionaire hedge-fund manager John Paulson, who famously shorted the subprime housing market before the crisis, was the single-largest investor in the SPDR Gold Trust (GLD) – the largest physical gold exchange-traded fund.

But according to the latest numbers from his hedge fund Paulson & Co, it cut its 21.8 million share position in GLD by more than half to 10.2 million shares. It was the first time it reduced the GLD position since 2011, citing "a reduced need for hedging."

Whatever the reason... The largest shareholder of GLD dumping half his position puts some pressure on the market.

But we've been seeing tons of signs the gold market has bottomed (here and here, for instance)... And here's another... Despite the S&P 500 and Dow Jones indexes both falling around 1.4%, gold stocks, as measured by the Market Vectors Gold Miners Fund (GDX), were up more than 5% on the day.

New 52-week highs (as of 8/14/13): Cisco (CSCO), SPDR Euro Stoxx 50 (FEX), Loews (L), and Steel Dynamics (STLD).

Making money in today's mailbag... What could be better? Send your feedback to feedback@stansberryresearch.com.

"Were you the guys that put me onto ROM? I am a VERY small and conservative trader and I bought 10 contract call options on it. Am up over $10.00. For me, that is a big deal. If you could let me know then I will pay more attention to you." – Paid-up subscriber Pat

Goldsmith comment: That was us... Steve Sjuggerud recommended the ProShares Ultra Technology Fund (ROM) to True Wealth readers in March 2011. Today, they're sitting on 43% gains. We're glad you're enjoying your profits.

"It seems pretty clear to me that Icahn or one of his underlings must be reading Dan Ferris... a pity that Ackman et al aren't." – Paid-up subscriber BB Gregory

Goldsmith comment: We'll ask him for a cut of his profits.

Regards,

Sean Goldsmith
Miami Beach, Florida
August 15, 2013