The S&A Digest: Shrinking Trading Volume Means Triple Digits for Us

Who will bail out the Treasury?... Singapore buys more of Merrill... Deficits don't matter... Zell buys mortgages... Einhorn's next victim... Our second-best ideas?... Porter's an 'urban bigot'?... Shrinking NYSE volume...

Yes, but who will bail out the Treasury?

After paying out 10% of its reserves to cover the losses of IndyMac, just one failed bank, the FDIC has come public with the obvious: It will need to "borrow" funds from the U.S. Treasury. Currently, the FDIC has 117 banks on its problem list, up from 90 last month.

So... the Treasury is now on the hook for 100 failed banks, $500 billion in mortgage losses (Fannie and Freddie bailout), another $500 billion or so in investment-bank losses, and another $500 billion or so in pension guarantees (the federal Pension Benefit Guaranty Corp has been wiped out by the steel industry and airline bankruptcies). And that's before we tackle the $50 trillion or so in Social Security and Medicare deficits...

How do you think this is all going to play out, dear subscriber? Do you think the government will simply insist the people who made these bad decisions be forced to live with the consequences? Or do you think it's far more likely the government will promise to staunch the financial wounds with huge amounts of additional money and credit – money that it never bothers to raise in taxes? That's easy, isn't it? And that's why the physical supplies of gold and silver bullion are disappearing. The "full faith and credit" of the U.S. government isn't worth much anymore.

On the subject of failing banks in need of capital, Temasek Holdings – the Singapore sovereign wealth fund – said it has "great confidence" in Merrill Lynch CEO John Thain and will raise its stake in the company. Temasek received U.S. antitrust approval yesterday to raise its stake to between 13% and 14%, up from 9.4%. Merrill shares are down 69% in the past year.

You might remember how many times you've heard "deficits don't matter" over the last decade. The vice president said so. Countless economists said the same about our current account deficit. And your banker probably said so, too, when it came time to refinance your mortgage.

Well, borrowing endlessly from foreigners does matter. We're seeing the inevitable conclusion right now: Our foreign creditors are buying everything worth owning in America. In 2007, foreigners spent $300 billion buying U.S. corporations. This year, that figure will probably exceed $500 billion. How many great American companies will still be owned by Americans in 10 years? Not Budweiser. Not Merrill Lynch. Not GM.

We're slowly carving out a bottom for mortgage-backed debt. Lone Star bought a huge chunk from Merrill, Sam Zell (who calls market tops and bottoms with remarkable accuracy) loaded up, and PIMCO – the world's largest bond manager – said today it's seeking up to $5 billion to buy debt. The Distressed Senior Credit Opportunities Fund will invest in "senior" and "super-senior" securities backed by commercial and residential mortgages. Senior debt is the first to be paid off in the case of default.

David Einhorn, of hedge fund Greenlight Capital, filed for an addition to his stake in MI Developments, a commercial real estate company. He now owns 10.9%. Einhorn attached a letter to MI's management in the filing, directly attacking CEO Frank Stronach and saying his business is in "serious financial trouble."

MI spun off Magna Entertainment Corp. (MEC), a horse-track operator, more than eight years ago. Despite a huge boom in the gaming industry, MEC "utterly failed as a business enterprise" and is a "case-study in mismanagement and poor resource allocation," according to Einhorn.

MI plans to loan the company more money in addition to continually extending the maturities of its existing debt. Einhorn argues more resources "will not resuscitate it under Mr. Stronach's leadership or anyone else he appoints to pursue his so-called vision." Einhorn's no stranger to a good ol' fashioned public bashing. He made a speech at this year's Grants Conference presenting his short case for Lehman Brothers. You can read the speech, here...

Don't look for a "Stansberry Field" anytime soon. Naming a stadium seems to be the kiss of death for corporations. Remember Enron Field in Houston? The Conseco Fieldhouse? Citigroup just paid $400 million to emblazon its name on the Mets' new stadium for 20 years. Citi shares are already down 63% this year, and it's scrambling to raise capital. We could think of better ways to spend that $400 million.

New high: Covidien (COV).

In the mailbag... We're frauds and bigots. And we never print any of the really critical e-mails we receive. Oh, yes, we do. Almost every single one. See below. And send yours to: feedback@stansberryresearch.com.

"I'm amazed at the number of people silly enough to attack or even criticize you, Porter. Don't they realize that you sit with the power cable of the microphone in your hand, and as such will only publish their mails provided you can win the little argument (at least to your own satisfaction). You will never publish a good and legitimate argument that puts you or your business in a bad light, and rightly so, but this makes the whole openness to criticism spiel a bit farcical.

"This brings me to the reason for writing today, for which I'll be surprised and humbled should I see it answered. I think S&A's biggest drawback is the fact that we as subscribers will always get your second best ideas. You and all of your associates have your own money invested all over the show, and everybody in the world will always invest his or her own money to the very best of their own ability, but since you're not allowed to buy anything you recommend to us, we as subscribers must necessarily get your leftovers ideas. This is worrying, to say the least, since any investor, even the great ones, can only hope to have a couple of good ideas per year." – Paid-up subscriber Eben van der Westhuizen

Porter comment: We publish the remarks we find most accurate, informative, and entertaining. The vast majority of remarks we publish are negative. I don't know of any other publisher in our industry that regularly does anything like what we do in our mailbag. I also don't know of any other publisher who publishes a Report Card on its own analysts each year, showing exactly how all of their stock picks have performed. We have great confidence in our publications, analysts, and subscribers. We're not afraid to deal openly and honestly with our shortcomings.

In regard to the issue you raise about "eating our own cooking," I can certainly understand your apprehension. We do not allow any analyst to own the stocks he covers for his readers. Why? First and foremost, because the SEC claims jurisdiction over things we write when those writings are done "in connection with the purchase or sale of a security." To maintain our publisher's exemption (and keep the ability to write what we believe about stocks, without passing our work through an SEC compliance officer), we must clearly distinguish between the stocks we personally buy and the stocks we cover for our readers. We know some other publishers don't maintain this bright line between their investing and their writing. They are putting themselves at risk of an SEC lawsuit. If they get big enough or successful enough, the government will shake them down.

It's true you might have more confidence in our analysis if we required our analysts to buy the stocks they recommend to you. But how would you feel when something goes wrong? It's inevitable some of our recommendations and some of our predictions won't pan out. Can you imagine what the letters in this mailbag would be like if our readers constantly accused us of recommending stocks only to pump up the value of the shares we own, so we could sell them ourselves for a profit? We'd spend more time defending ourselves in court than researching stocks. Our rule against owning the stocks we cover at least assures you our mistakes are honest ones.

Lastly, if you're worried about getting our "second-best" ideas, you don't understand human nature or economics. Things just don't work the way you're assuming they do. Imagine... What if I had decided to keep to myself my insight that Fannie and Freddie were going to zero? I might have made 90% gains in two months on a $100,000 investment, which would have been an aggressive position size. I could have made a quick $90,000. Instead, I published my research, made my subscribers a ton of money, got my name and my ideas sent all over Wall Street, and was republished on the front page of Barron's by the legendary Alan Abelson. Which do you think was more in my self-interest?

All of our analysts stand to gain far more wealth and recognition by making great recommendations for our readers than they do turning a profit from their own trading. Besides, it's nearly impossible to know in advance which recommendations will end up being great. Maybe if it were easier to cherry-pick, there would be a problem.

You're also ignoring the fact that our analysts can usually invest alongside readers in "side cars" – nearly identical companies. Take my most recent recommendation of a bond insurance firm. I considered recommending two nearly identical businesses. One has a stronger balance sheet than the other – it's clearly the better choice. I recommended that firm to my readers. I took the other stock for myself. So I'm invested alongside my readers, but in a slightly less-attractive vehicle. It's a tax we all pay regularly – and happily – around here. Serving our readers is what we do.

If you don't believe that's the truth, ask for a refund. We're always happy to part as friends.

"Sorry to correct you, but in your response to Bob Barry in Monday's (8/25) Digest, you indicated that Alex Green's '"Gone Fishin' Portfolio"... uses exclusively Fidelity No-load Funds.' Actually this portfolio is composed almost exclusively of Vanguard Funds and not Fidelity. Other than that I consider The Digest a must read on a daily basis. It is one of my few connections to sanity." – Paid-up subscriber Mike Riley

Porter comment: We appreciate the correction and regret the mistake. Mr. Riley is quite correct. Our friend Alex Green's strategy is based on using Vanguard funds – which have the lowest fees in the industry. His book is a must-read for anyone looking for a very safe, logical, and efficient way to manage assets.

"I've been meaning to send you a thank you for quite some time and was just reminded when looking over my results from your PSIA recos. I normally just follow your direct recommendations, but every once in awhile I use a LEAP to try to juice the returns. Of course, I've had losses, but the winners far out pace them. My best LEAP so far was on Akamai when you recommended to buy it under $20. I bought 15 Jan 07 $25 calls for a total investment of $1,425 and cashed them out for a total of $23,535. The way I calculate it, that was about a 1,651% return within a year. I could have done even better if I'd held them all longer, but I guess I shouldn't complain. I'm trying this same strategy on your JDSU reco and of course I'm only doing this with my speculative money." – Paid-up subscriber Chris F.

"Stansberry, You are a typical urban jerk, who thinks the middle 15/16ths of the country is inhabited by poor, dull, inbred rednecks. You've shown your true color- bigot." – Paid-up subscriber Dan

Porter comment: Uh... I have no idea where this comment comes from. I've long extolled the virtues of Scott County, Tennessee, which is the farthest thing I can imagine from an urban center. Here's a picture of my hound dog hanging out on the back porch. Hope you are all enjoying this last week of summer. We're having a great time here in Scott County.

Regards,

Porter Stansberry

Scott County, Tennessee

August 27, 2008

Shrinking Trading Volume Means Triple Digits for Us

Ian Davis

In 1817, the New York Stock Exchange opened its doors for the first time. At the time, the NYSE was no more than a rented room at 40 Wall Street. But even that paltry room was excessive.

Back then, stocks were traded in a "call market." The president of the exchange would shout out the name of each stock, and brokers traded each one in turn. There were two trading sessions each day, one in the morning and one in the afternoon... No more than a couple hundred shares traded hands each day.

Trading volume on the NYSE has increased by about 4 million percent since the first year it opened. This past Monday, roughly 859.6 million shares traded hands. And Monday was actually the lowest-volume trading day in the last six months.

In fact, the volume of shares on the NYSE has been shrinking for the last five years. The daily turnover is about 5% lower today than in 2003.

This reduction is unusual. Over the 46 years leading up to 2003, the NYSE volume increased by roughly 15% per year. Barring a short stint in the late '80s, the growth has been amazingly consistent. Just look at the following chart:

The NYSE Volume Has Been Shrinking Since 2003

So what is putting such a damper on trading growth?

Perhaps volume is naturally plateauing because everyone who wants to trade stocks is already doing so... The U.S. does have the largest and most developed stock market in the world. But I think it's something else, something patient investors can use to their advantage... Many investors are hesitant about the market right now, but those of us who don't wait on the sidelines could make triple digits off this opportunity. Let me explain...

In 1837, the NYSE's trading volume fell 80% (from 7,393 shares per day in January to 1,534 by June).

This occurred during the aftermath of the 1837 panic... a crisis that hit when banks stopped payment in gold and silver coins. A five-year depression followed the panic. Many banks failed, and unemployment rose to record highs.

Volume plummeted again in the 1930s, following the stock market crash of 1929.

It fell from an average of about 2 million shares per day in 1929 to 750,000 shares in 1930. This panic kicked off the Great Depression... an economic recession that lasted nine years.

And finally, in 1987, we saw the largest down day in the history of the stock market... Black Monday. The Dow Jones Industrial Average fell 22.6% on the day. People panicked and – as you can see from the above chart – trading volume stagnated. The average daily volume on the NYSE fell about 12% over the following two years.

Fast-forward to today, and you'll see investors are once again gripped by panic. This panic began with the collapse of Internet stocks in the early 2000s. Then, just as investors were starting to creep back into the market, homebuilders crashed in 2005 and real estate and financial stocks followed in their wake. I think that's why trading volume has been on the decline.

If you have the cash, these are great times to invest. The late '80s kicked off the greatest economic expansion in the history of the U.S. If you'd put your money to work during the Great Depression, you could have made a boatload. The markets bottomed in 1933. By 1939, the stock market was up more than 100%.

So while I'd avoid some of the riskier financial stocks, I wouldn't abandon the stock market altogether. Now is a great time to go bargain hunting.

Good investing,

Ian Davis

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