The real reason stocks have gone down for more than 10 years...

Another Friday... another Friday Digest. For new subscribers (and luckily, a few new folks joined us this week)... you should know that on Fridays, I tilt at windmills. I write the Digest myself. And I do my best to teach you something you probably don't already know about finance... something that's useful and will actually make you a better investor. Today, I'm going to show you precisely why stocks have been a terrible investment (in general) over the last decade. Once you understand one certain factor in the value of stocks, I promise you'll never invest the same way again.

Before we get to the serious information, I'd like to explain why I say I'm "tilting at windmills." By and large, people cannot be taught anything. Or as I say: There is no teaching. There is only learning. That's because until you recognize the value and importance of learning the basics of finance, you'll never read these messages carefully or internalize any of their meaning. I don't say this to insult you. I say it primarily because it's simply the truth. Once you realize that truth, it will change your life. You can learn anything. But only if you choose to. There is no teaching. There is only learning.

One more thing... if you find these introductions overbearing... you're not the only one. Mondays continue to be the busiest day in our office for refunds. Most people hate the idea that they will have to learn anything to be successful. Their attitude is, "Hey, I paid my $49... you do the thinking for me."

Unfortunately, nothing in life is that simple. I write these weekly lessons primarily because I know that unless you understand the basics, our newsletters won't help you. My sincere desire is to always give you the information I'd want if our roles were reversed. I know the most valuable information I have to share isn't just a stock tip, it's the understanding of how you ought to use that tip.

The chart below shows you the price-to-book ratio of the S&P 500 over the last decade. For those of you who are new to finance... that's probably just a bunch of gibberish. So let me decode it for you…

The S&P 500 is a list of stocks published by the credit-ratings agency Standard & Poor's (S&P). It is essentially the 500 largest and most successful companies in the United States. This list of stocks is also commonly used as a shorthand way to reference the entire stock market. It's comprised of stocks from every sector of the marketplace and is thus representative of stocks as a whole.

The book-value ratio is even easier to understand. Book value is one simple measure of a company's net assets. It's not a perfect measure, not by a long shot. But used across a huge index of stocks, it's fine for making comparisons across time. The book-value ratio simply refers to the ratio of dividing a stock's total stock market value (the total value of all of its shares) by its book value.

This measure gives you a rough idea of whether stocks are expensive (overpriced relative to their assets) or cheap (and thus attractive for investors). The lower the book-value ratio, the better the value. As you can see on the chart below, the average book value of the S&P 500 has gone from nearly five to around two.

In the above chart, you can see that stocks were extremely expensive back in 2000. And they've been getting cheaper and cheaper ever since. You could make the same kind of chart using an earnings-per-share ratio or even a cash-flow ratio. The charts would all look basically the same. Most investors didn't realize back in the late 1990s and early 2000s that U.S. stocks were trading at multiples of net assets and earnings that the world had never seen before. That is, relative to the underlying assets and the annual earnings, stocks were more expensive than they'd ever been before... ever. So why is that important now?

Most investors have lost money in stocks over the last decade because they've been holding stocks that on average have been getting cheaper and cheaper relative to the underlying intrinsic value of the businesses they represent. Take Wal-Mart, as one example...

In 2000, shares of Wal-Mart peaked at $70 per share, when it was trading for more than 50 times earnings. Since that time, the share price has basically gone nowhere. (Today, the shares trade for a little less than $60.) Meanwhile, the value of the underlying business has soared. Last year alone, Wal-Mart produced $23 billion in cash earnings, bought back $14 billion in stock, and paid out more than $4 billion in cash dividends. If Wal-Mart still traded at a 50x multiple, the company would be worth nearly $1 trillion today, instead of "only" $200 billion.

What should matter to investors – how much the company is capable of earning and distributing in dividends – rarely does. That's why you have a great opportunity today to buy super-high-quality stocks, like Wal-Mart. However, let me caution you... I don't think people, by and large, are going to do well in stocks until the market's average multiple begins increasing again.

That is, until investors become willing to pay a higher price for stocks, the returns on a portfolio of stocks is likely to be marginal and probably not worth the risk. That's why I've been urging subscribers to think about high-yield bonds. And why I've told people that unless they're able and willing to speculate and hedge (more on this in a moment), they shouldn't even own stocks at all.

Instead, since March 2010, I've been telling most investors to simply hold 50% of their investing portfolio in gold and 50% in short-term Treasurys. The chart below compares the total return of the S&P 500 to the hypothetical return of a portfolio made up of 50% gold and 50% short-term Treasury bills (as represented here by the SHY ETF – a mutual fund that owns one- to three-year-duration Treasury bills). The black line (the underperforming line) is the S&P 500 – our proxy for stocks in general.

The blue line is our recommended 50/50 gold and Treasury bill hypothetical portfolio. Which would you rather have owned? The answer, of course, is simple. The gold and Treasury bill portfolio has a much higher total return (25%) and much less volatility…

Investors have been unwilling to pay up for stocks for one good and simple reason: They don't trust the current monetary system, which has suffered crisis after crisis. Investors have no way to know what's going to happen next in the world economy because the monetary system itself is so fragile right now. As a result, they're extremely reluctant to pay up for future earnings.

The stock market's average multiple – how much people are willing to pay for stocks – is a measure of investor confidence. Confidence keeps falling because the fundamentals keep getting worse. More European countries are at risk of default. America continues to run enormous, $1 trillion-plus annual deficits. Central banks around the world have begun to flee the U.S. dollar standard, turning to gold instead. There's a profound lack of confidence in America's current political leadership (on both sides of the aisle) to do anything meaningful to improve business conditions. Most investors seem to be waiting for the next shoe to drop. As you know, my position is that they are smart to worry.

The situation leaves most investors in a terrible position. They can't earn a good return in stocks because of the volatility and the gradual, but continuing, decline in the market's average multiple. The result is, even when earnings go up, stock prices don't. Most bond yields are too low to live on. And most stock dividends are, too. If you're not earning capital gains and you're not making good income from coupons and dividends... what can you do?

The unfortunate reality is that in a crisis (and yes, we're in one), the best you should realistically hope to do is protect what you have. That's why I've been advocating gold/Treasury bills. We've done well – better than I expected – with this strategy. This is the best way to stay "liquid," so that you'll keep your purchasing power and have ready cash to invest when this crisis reaches its final, massive, liquidating panic.

No, I don't know when that will happen... But I know it will happen. And you will definitely know when it does.

If you want to do better than that, you're going to have to learn how to speculate. That means shorting stocks. That means trading options. I know most of you will never do these things. That's fine. You should never do something you don't understand. But...

We've been trying to really educate people about how to trade safely – especially folks who are retired – because that's one of the best ways to generate income right now. A market like this one – with a declining multiple and lots of uncertainty – is a paradise for traders. Let me show you what one new subscriber to Dr. David "Doc" Eifrig's Retirement Trader sent us yesterday.

I want to publicly congratulate Doc on his amazing accomplishments over the past year. We asked him to design a strategy that would take very, very little risk, but generate lots of income for our readers. Over the past 18 months, he's closed 47 positions – all winners – and generated 8.84% in returns on average (most of it in current income).

I'm confident Doc could safely and successfully trade in any market. He used to do these kinds of trades at the highest level of finance – the proprietary trading desk at Goldman Sachs. But I'm also certain we may never see a better environment for short-term trading. Volatility and fear is terrible for investors. But it is manna for traders. To learn more about Retirement Trader, click here.

I hope this clears up the situation for you in stocks. The good news, besides for traders, is that as stocks get cheaper and cheaper, the public will eventually get tired of buying them and holding them. Sooner or later, we'll see a moment of "capitulation." Stocks will have fallen for so long, everyone will simply give up on ever seeing another real bull market again… At this coming bottom, you'll see most stocks trading for less than book value. You'll see blue-chip stocks yielding 10% or more in cash. That will be the time to buy and hold.

Unfortunately – human nature being what it is – most of the people reading this message will have long since stopped reading my newsletter by then. They will have already given up. Don't be one of those folks.

There are plenty of ways to do well in this market. You can do well by being conservative. Or you can do well by trading. Whatever path you choose, just make sure you know what you're doing and why you're doing it.

One last note... We knew it wouldn't take long to offend someone on the radio show. But we admit... we were very surprised who got offended and how it all happened. I explain all the details in the latest show. If you've never listened to Stansberry Radio, this is an episode you don't want to miss.

The latest episode of Stansberry Radio – our second – is now available. You can find it on iTunes here or listen to it immediately here.

Next week, we'll interview Rick Rule. Sign up here to make sure you don't miss it.

New 52-week highs (as of 12/1/11): Enterprise Products Partners (EPD).

In today's mailbag, our subscribers think back to the good, old days... when the dollar was worth something. Send your e-mail to feedback@stansberryresearch.com.

"In the The S&A Digest for 12/1/2011, it says:

"I certainly agree that the U.S. dollar is garbage now, but being somewhat of a history buff, at the inception of the dollar, its value was fixed to silver and was a hard currency.

"The U.S. dollar originally was defined April 2, 1792 as a unit of weight equaling 371 4/16th grains (24.057 grams) of pure silver, or 416 grains of standard silver (standard silver being defined as 1485 parts fine silver to 179 parts alloy). By that definition, with silver currently at $32.71 / troy ounce, the current dollar is worth 0.0236452919596454 of what it was, or 2.36452919596454 cents. The dollar was not always garbage." – Paid-up subscriber John Griffiths

"And if you want to get a look at what you can expect from stocks over the next several years, just look at the 1970s. From 1974 through 1984, the Dow Jones Industrials Average traded at less than 10 times earnings on average. That's really cheap, as investors demanded higher returns to compensate them during those inflationary years following the total elimination of the gold standard for the U.S. dollar in August 1971.

"Yea! Someone who learns from the past.

"Please remember also, that during that time period the very best managed banks in the country, with growing earnings, fortress balance sheets, zero asset quality issues, stellar ROAs and ROEs, were trading at 50% of book and five times earnings." – Paid-up subscriber MM

Regards,

Porter Stansberry

Baltimore, Maryland

December 2, 2011

The real reason stocks have gone down for more than 10 years... More tilting... Porter's already ruffling feathers on the radio show... Wal-Mart could triple... Doc's nearly perfect trading strategy... And why the current market is a 'golden age' for traders...