The S&A Digest: An Update from GM's Chairman

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/27/2013

Another letter from GM's chairman... Another hedge fund goes down... Basel II... Goldman is junk... Johnson & Johnson trims the fat...

General Motors (GM) racked up its third-straight quarter of profits. Last quarter, the world's largest automaker brought in $891 million... quite a change from the $3.4 billion loss in the same period last year. GM credited improved sales, especially in growing markets. And... the company's chairman has once again sent us a private letter... explaining all of the details (see below).

PSIA pick Johnson & Johnson (JNJ) announced today that it plans to reduce its global workforce by 4%, as a number of its patents will soon expire. The drugmaker, which employs 121,000, expects pretax charges of $550 million to $750 million in the second half of 2007. However, JNJ also expects $1.3 billion to $1.6 billion in savings for 2008.

S&A Gold Report pick Southern Copper (PCU) announced its Tia Maria project in Peru could produce 90,000 tons of copper each year, more than double the initially projected amount. A feasibility study will be ready by the end of the third quarter 2007. Shares gained 2.5% on the news. Subscribers have already made 180%.

Borrowing short and lending long is a great business... up until the moment you can't borrow short anymore. American Home Mortgage was cut off, starting three weeks ago. It is now, apparently, insolvent. Likewise with hedge fund Sowood Capital... Sowood's managers must not have studied Keynes, who predicted the sorrows of every highly margined investor: "The market can stay irrational longer than I can stay solvent."

Sowood lost half of its $3 billion as the credit spread (the difference in the risk of holding any entity's debt versus holding the risk-free debt of U.S. government bonds) grew a little wider. Yesterday, the fund announced it would sell its open positions to Chicago-based hedge fund Citadel, and return $1.5 billion to investors.

Of course, we don't truly mourn for either the hedge fund managers or their investors. Instead, we assume what's said about such limited partnerships is probably true. At the beginning, the limited partners have capital and the general partner has experience. Later, the roles are reversed. We assume that next time the limited partners will try funding their tuition at a more reasonable price.

We do worry, however, about what will happen to the supply of credit in America. Under the guidelines of Basel II (trust me, you don't want to know...) banks and brokers must hold $0.56 of capital to each $100 of triple-A rated investments. Incredibly... bundles of mortgages were rated AAA in 2005 and 2006, despite containing adjustable-rate loans and so-called "liar loans" – no-document mortgages.

Banks, brokers, and hedge funds bought these securitized mortgages... because in addition to being triple-A rated, these loan packages had the even more envious quality of paying a few extra hundred basis points in interest than U.S. treasuries. But... as mortgages default... sooner or later, these loan packages must be downgraded. So far, Moody's has downgraded 339 residential loan packages and placed another 32 on "credit watch."

How much capital, you might wonder, will your bank or broker have to come up with to meet the requirements of Basel II in the event that their mortgage investments are downgraded to, say, below investment grade, or BBB? In that case, the bank or broker needs to hold $4.80 in capital per $100 invested – or eight times more capital than they needed when they were holding AAA investments. Where will the capital come from? Banks and brokers will be forced to "call in" their loans...

We're about to witness what happens when credit contracts. I suspect this will cause quite a shock to my fellow Americans, who have become addicted to the never-ending river of easy credit.

It is this risk of a true credit contraction that's sent the bonds of Goldman Sachs, Bear Stearns, Merrill Lynch, and Lehman Brothers into "junk" range. According to credit default swaps based on these banks' bonds, their credit ratings are below investment grade. Bonds of these banks lost about $1.5 billion in face value this month. The highest level of defaults in 10 years and a $33 billion pileup of unsold bonds are sending investors running from the New York firms.

PSIA pick Verizon (VZ) will acquire Rural Cellular for $2.67 billion. The deal will expand Verizon's coverage in rural markets and add 700,000 subscribers – not an overwhelming number considering the 1.3 million subscribers Verizon added last quarter. The company will pay $757 million in cash and assume the rest in debt.

Company of the day: Cambridge Display Technology (OLED) develops polymer organic, light-emitting diodes (PLEDs) for use in flat panel displays and other electronics. PLEDs have many advantages over traditional LCD displays... They do not require backlights, they give clearer images and require less energy, they are cheaper to produce, and they have better viewing angles. Cambridge, a $155 million company yesterday, has yet to turn a profit. Today, its Japanese licensee, Sumitomo Chemical, agreed to take Cambridge over for $12 a share, a 97% premium.

New highs: Sigma-Aldrich (SIAL), Gen-Probe (GPRO), Seabridge Gold (SA).

We spent our time this morning reading the GM earnings announcement, so we had to cut the mailbag a little short. Don't worry. Your venom doesn't carry an expiration date. We'll jump back in tomorrow. Send your criticisms, praise, and comments to: feedback@stansberryresearch.com.

"How could you guys pick such a bunch of underperforming losers as you recently have? Most are down 20%-30% already. Just look at SIX. What a disastrous pick if ever I've seen one." – Paid-up subscriber Allan Boote

Porter comment: They're certainly not all winners... but our S&A 16 Model Portfolio, which we picked near the top of the market in early July, is only down 2%. If you've stuck with our safer picks, you've done fine.

"Just about every newsletter I subscribe to & maybe even the Oxford Club are announcing the arrival of Bulletin Board Elite and advising, 'Hurry now, we've almost sold out our allotted 2,000 openings!' A big accolade goes to you for your alert regarding the BBE's major shortcomings, which are not listed anyplace else. Thank you." – Paid-up subscriber JRM

Porter comment: We only mentioned the normal pitfalls in buying bulletin board stocks, which we believe the publishers will be hard-pressed to overcome. But, as it is a new service, we've withheld our judgment on its usefulness. Since it comes with a 30-day money-back guarantee, we saw no harm in letting you know about the offer, on a trial basis. If you've subscribed, please let us know how it's going.

"I was just thinking about those 23 new helicopters they just ordered for the president. Maybe while some are sitting idle, they could be put to better use, like ferrying illegal Mexicans back and forth to their home when they get homesick. As a very happy taxpayer, I don't like to waste any useful property we own. I am sure you can think up a lot of other good uses for these helicopters also." – Paid-up subscriber Bob R.

Porter comment: Didn't Bernanke once mention something about dropping cash from helicopters?

"The only thing that makes this whole AHM debacle bearable is that I finally learned the lesson of 'not hanging onto a losing position' and the $1,400 in dividends that were credited to my brokerage account on Friday. Of course, I still lost money, but it could have been a whole lot worse. So, in one way, I'm sorry I followed your advice to purchase and lost money, but I am glad I listened to your advice that subscribers should 'watch out for their Alt-A's' and remember that they have not been completely honest." – Paid-up subscriber Dave S.

Porter comment: Never let a losing position become a debacle...

"You need to be careful in your sweeping generalizations. As a UF graduate engineer, I do not see any alternative to new scientists/engineers to going to college. It is not a farce. Higher math and engineering is not going to be learned, and also importantly, you cannot get a job, without it. Go to St. Johns and learn Greek if you want your kid to be a businessperson, but, if they have an interest in engineering, go to a good engineering college... and the UF is one of the best! Similarly for any medical interest. Would you go to a self-taught doctor? Don't be so narrow minded." – Paid-up subscriber Curt Whitney

Porter comment: Don't be narrow-minded? Mmn...

"What an absolute BS, your rambling about the value of college education! In the post-industrial economy (or call it whatever you want to call it) one will barely be able to make a living without college education. Certainly not a middle class or better living. I know nothing about the Florida college where you went, maybe it is useless as far as experience with investments is concerned. However, not everyone will make his/her living by trading stocks. Most of us, your customers, actually work regular jobs and many of us create value by our work. In order to do this, whether you are in engineering, like I am, or medicine, or anywhere else, you need to learn the basics and the theory in order to function. As every good university teaches you, life is constant learning and the most important thing you learn in a good college is how to keep learning throughout your life. I have nothing against investing per se, but most of us first made some money before we started investing. And, I bet that the vast majority of your subscribers were able to make the money that they are investing based on your advice, utilizing their college education. Of course, if you are born into a rich family, you may not need college. But then, what will you do with your life aside of getting bored and probably ending up on drugs...?" – Paid-up subscriber Thomas

"Your recommendation of AHM stuck in my head as an ill-conceived investment and why I didn't trust my gut when I've lost money before through your specific newsletter beats me. You, Porter, seem to give the poorest advise of any in your corral of 'experts.'" – Paid-up subscriber JB

Porter comment: Maybe I should have paid more attention in college...

"Many investment letters talk about the rising gold and plummeting US dollar. Often there is this almost like glee when an analyst (yours too) talks about how the dollar will be next to worthless. Please help me to understand; if, let's say, the dollar loses another 50% of its current value... then wouldn't gold have to rise 100% just to compensate for the dollar's fall? Gold does protect one from inflation, but in order to be a great investment, it must do much better than what it has been doing lately. In the last 5 years, the dollar has lost about 40% of its value, but gold has not increased enough in value to compensate for this... or am I not seeing this right?"

– Paid-up subscriber Timoyla

Porter comment: Gold is up more than 120% in the past five years. Silver is up more than 180%. Seems like they're "compensating" to us.

Good investing,

Porter Stansberry

Baltimore, Maryland

An Update from GM's Chairman

By Porter Stansberry

Well... shareholders... with hard work and a few new cars, we're continuing to produce enough cash to keep us going. And that's great news for our retirees...

Let me explain.

The global boom is powering our sales in emerging markets. GM Latin America, Africa, and Middle East posted its best quarterly profits in a decade. Volume is up more than 20% from a year ago. We set sales records in almost every place commodities are mined, drilled, or refined: Argentina, Brazil, Chile, Colombia, Egypt, and the Middle East. In the past quarter, we recorded a $213 million profit. If gas prices continue to soar, we'll go broke selling cars in America... but we'll make millions selling cars in those countries that actually have oil coming out of the ground.

The foreign momentum continued in other areas too, as the global credit cycle reached a peak this spring. Everyone, it seems, had cash to spend. We set volume records in South Korea and India and continued to do well in China. Profits of $237 million were, again, at a record high for the quarter.

These foreign profits helped us report net income of $891 million and produce $1.1 billion in cash flow for the second quarter. And I know... that sounds great. Especially compared to the $3.4 billion we lost in last year's second quarter.

But... as they say... the sun even shines on a dog's ass every now and then. Unless we're able to turn around our North American unit, the few hundred million we're making in Latin America and Asia won't be nearly enough to repay our debts. Unfortunately, there are more than a few things in these results we're hoping our creditors won't notice...

For example, most of the $1.1 billion we're touting as cash in the door last quarter came from two one-time credits. First, we received a $401 million tax benefit. And second, we took $139 million from GMAC's profits. (We only own 49% of GMAC now. We had to sell it because our credit rating dropped to "junk" status.) Almost all of GMAC's profits this quarter came from the sale of an asset – ironically, a homebuilding company. We can't count on profits from GMAC anymore. We wrote a bunch of commercial real estate mortgages... and, between you and me, I don't think most of them are worth the paper they're written on.

So... the good news is that we made $500 million or so in foreign markets. But the very thing that's powering these economies (commodity prices) is killing us at home. And, while it's nice to have cash coming in the door for once, none of this "windfall" addresses our most fundamental problem: a shrinking asset-base weighed down by a huge debt burden.

Money did come in the door last quarter, but our share of the global car business continued to decline. GM's global market share now sits at 13.3%, compared to 13.7% a year ago. Worse still, the latest figures show that our health care liabilities now total $60 billion. We've only put $18 billion into the kitty to pay for these liabilities, so far. Even after the sale of our $5.6 billion Allison Transmission unit and even if you knock off 25% of the total we owe (which we think the union will give us), we're still about $15 billion short on health care funding.

And that's not to mention the $40 billion or so we owe Wall Street's banks.

As long as our share of the global car market continues to decline, there is no way for us to ever repay these obligations. Of course, if Hillary Clinton wins the election... we might not have to...

Regards,

Your Chairman

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame