The S&A Digest: The Panicking Investor

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

As of 06/27/2013

How much can you make on the bounce?... AHM shuts down... Hazlitt on mortgages... Chinese bailout?... Dreman is buying... Ferris takes a hit... Farces, frauds, and colleges... Our best ideas now...

The mortgage meltdown continues... Shares of American Home Mortgage (AHM) didn't open for trading today, after the company announced its credit facilities were being withdrawn. The banks that backed AHM in the past now don't believe the company's mortgages are worthy collateral. The "run on the bank" means AHM won't pay dividends on its common stocks and might not be able to pay on its preferred shares either.

This announcement comes less than a month after AHM affirmed its dividend policy and said it would survive the downturn. Hopefully all of you have long since exited the stock, which I told my readers to sell after taking a 30%-plus loss. In the most recent issue of my newsletter, I wrote:

Speculation on Wall Street is that "Alt-A" debt will be downgraded next. Most of the loans held by American Home Mortgage are considered "Alt-A" because they have adjustable rates. Even with the high credit scores of the company's borrowers, if rating agencies downgrade the bonds it holds, the company's solvency will certainly come into doubt. Whether this happens or not is a moot point for us: Our speculation hasn't panned out. We should have realized it sooner... but in a few more weeks we might be very glad we got out while we could.

– Porter Stansberry's Investment Advisory, July 2007

The collapse of a credit bubble is far worse than the ending of a stock market bubble. As Henry Hazlitt wrote over 60 years ago in his classic, Economics in One Lesson:

Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to "buy" houses that they cannot really afford. They tend eventually to bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief in the long run they do not increase overall national production but encourage malinvestment.

You can read Hazlitt's book for free online here...

Who will bail Americans out of their bad debts? The Chinese of course. Bloomberg reports: "The Bush administration is urging China's central bank to buy more government-backed mortgage bonds in an effort to sustain financing for U.S. home loans. U.S. Department of Housing and Urban Development Secretary Alphonso Jackson is in Beijing to persuade the Chinese central bank to buy more securities from Ginnie Mae, a corporation under HUD that guarantees $417 billion in federally insured, fixed-rate mortgages..."

How bad is this market? We asked Jeff Clark: "...At the start of last week, just over 60% of the S&P 500 was trading above the 50-day moving average. This indicates that the majority of the stocks in the index were in an uptrend. Today, however, only 18% of the stocks are trading above the 50-day moving average. This is a truly extreme development... The same extremely oversold condition is present in the NYSE high-low index. This index, which measures the percentage of stocks on the New York Stock Exchange that are trading at new highs, has dropped from more than 70% last Monday to less than 4% today."

It's the single hardest lesson to learn. To be a great investor, you need both an information advantage and an emotional edge. You must be eager to buy what others are afraid to hold, but only when you can know, for certain, the value you're getting.

David Dreman has been one of the world's best investors for nearly 40 years. He's buying two mortgage companies right now, with serious amounts of money. He's bought 3.2% of Newcastle (NCT) and 5.6% of JER Investors Trust (JRT). Dreman isn't the only one bullish on mortgages. Garrett Thornburg of Inside Strategist and 12% Letter pick Thornburg Mortgage (TMA) bought $6 million of his company's stock last week.

It's no secret that Dan Ferris is the best equity analyst on our staff. We think he's proven himself to be one of the greatest stock analysts in the world – judging by his track record over the last five years. However, the recent downturn in stocks hasn't been kind to Dan's S&A Penny Letter portfolio. We knew these stocks would be more volatile than his Extreme Value recommendations. The question is: Will our subscribers use this volatility to their advantage... or suffer from it?

Says Dan: "If you could have asked the stock market what it was thinking on Friday, it would have told you that it hates the S&A Penny Letter Model Portfolio..." With most of Dan's picks off more than double-digit percentages, our readers are faced with a tough decision. Will they stick with Dan (who says to hold on) or will they give in to their emotions?

Get ready to buy? After last week's $2.1 trillion global fallout, U.S. equities are at their cheapest point in 16 years. Stocks are now trading at 15.4 times earnings, the lowest multiple since January 1991. The Dow and S&P 500 lost 4.2% and 4.9%, respectively, last week.

Phase 1 pick Crucell (CRXL) this morning announced a co-exclusive PER.C6 and Advac technology license agreement with Wyeth. Under the terms of the agreement, Crucell will receive an up-front payment, milestone payments, maintenance fees, and royalty payments on net sales. The stock, already the best performing pick in the Phase 1 portfolio, returning more than 200%, gained 2.5% on the news.

Company of the day: Deckers Outdoor (DECK) produces shoes under brand names Teva, UGG, and Simple. The $1.4 billion company trades for 40 times earnings and has $25 million in cash and zero debt. DECK has annual revenues of more than $310 million and cash flows of close to $50 million. Shares of DECK have run up 84% since January, and insiders have sold a combined 810,000 shares over the same time period.

New highs: Gen-Probe (GPRO) and UltraShort Real Estate ProShares (SRS).

We got a lot of action in the mailbag over the weekend... and hardly anything about the correction. The insults and jabs have faded. Instead, someone refers to me as "master." I can get behind that change. Let us know how you're doing... feedback@stansberryresearch.com.

"I have been investing in silver and gold because I believe it is going to rise but I have a question for you regarding the possibility of deflation. Do you believe that deflation of the dollar and other currencies will have a negative effect on silver and gold? If currencies continue to fall in value, will precious metals follow suit?" – Paid-up subscriber Daniel Duke

Porter comment: Your question assumes two contradictory scenarios... but I'll answer the question I think you're getting at. By definition, deflation is the rising value of money versus commodities. Ergo, if we were to experience deflation, the price of gold and silver would fall.

However, under a global paper standard of money managed by a spendthrift democracy (the U.S.) this will not occur. (People cite the Japanese deflation of the 1990s... but that's nonsensical. The yen has never been the world's reserve currency.) What will happen when the U.S. credit bubble finally collapses or when there's a run on the dollar? Don't you remember the 1970s? People will be less likely to accept the dollar, Bernanke will turn on the printing presses, and precious metals will soar.

"Chris Weber did an article which ran in DailyWealth on July 25 about physical gold and silver. I thought your subscribers might be interested in information on holding physical precious metals in their IRA. Some brokerages, like mine, will only allow certain coins to be held. There are only 2 companies I know of that will do bars of precious metals in an IRA. Last October, I talked with the IRS to make sure of what was allowed. They gave me this address, which lists the companies that deal in these IRAs and also a list of what is allowed to be held in them. The website still lists American Church Trust, but they have been bought out by GoldStar Trust Company, PO Box 719, Canyon, Texas 79015 (800-486-6888). I opened a new account and transferred funds from my other IRA in order to get this done. I purchased my bars from Investment Rarities in Minnesota but I believe they can be purchased from other dealers as well." – Paid-up subscriber Mary Bohlander

"Fortunately, my parents insisted we all get college educations, and put their money where their mouth was. That being said, remember that colleges are like carborundum: good for polishing pebbles, but likely to dim a diamond. Or, as Woody Allen put it: "Those who can, do; those who can't, teach; those who can't teach, teach gym!" The key to this is that college is more about who you meet, and how you can leverage those friendships in the future. They are like the bassinet after exiting the womb – a place to stretch out, but still mostly protected. In the end, whether you enter the military or college, or head out into the world, it's only what YOU learn that does any good. One point of this was a comment by a recruiter (back in the early seventies), to the effect that while they (the company) can teach you everything you'll need to know, the fact that you spent time and money on college gives them a statistically significant indication that you can be educated and that you probably won't be happy digging ditches instead, so you'll probably stay the course." – Paid-up subscriber Don Nollet

"Interesting comments about college... I think you make a very valid point. I see the stuff you teach is not what you get from a college degree. My viewpoint is similar... I am a physical therapist. My degree gets me entry into the medical model. But what I use to help patients is to a large extent what I learned after school. 75% what I learned in college was a waste... Similar to your situation. I learned a ton of information (after school) from a master guru. She was passionate, committed, bright, and arrogant. I just listen to her talk... I think the same way of you. I think you are a master of your craft, passionate, committed, bright, and arrogant. You have learned a ton after college. And you are a master. And I like to hear you talk... I also listen to comments from masters like Mike Masterson and Andrew Weil MD... Your risk/reward analysis makes a ton of sense. Our brains function in such a way that learning occurs after 5-8 occurrences and variations. So that is why your readers do not get it the first time... Be patient, master." – Paid-up subscriber Ray

Porter comment: There's a life cycle to ideas and institutions. No good institution ever survives unscathed. Sooner or later, it is rendered useless, a shadow of its former self. It lives on its previous reputation, sometimes for a long, long time. But eventually, the entire thing becomes a farce... and then a fraud.

College was a great idea... 50 years ago. It gave middle class men (and women) a chance to mingle with the upper class and to learn what couldn't be taught in public schools – demanding courses like Greek, advanced mathematics, engineering, chemistry, etc. To veterans returning from WWII, college was the onramp to a booming U.S. economy. But... of course... as college became more popular and more common, the whole thing turned into a farce.

Every middle class American can't become part of the upper class. And the more kids that got pushed into the "college" pipeline, the worse the education they received. Instead of learning anything remotely useful in high school, everyone was being instructed to pass the SAT. But what good will this do most of them? At some point, maybe about the time Animal House was produced, college became a farce. It was merely a middle class right of passage.

Gone were the lessons of Greek and Latin... or any other truly rare and refined instruction. Curriculum instead became based on the politics, passions, and fads of the day. Thus... there were classes on Hollywood movies, on "deconstructing" poorly written novels... on how to lift weights, and so on. By the 1980s, you could achieve a college degree without spending any money (the government would pay) and without learning a thing. I know. It happened to me.

And now? College has become a fraud. You can take "classes" on the Internet... or through the mail. The curriculum has become ever more absurd. But now, at least someone is making a lot of money selling "college." College sports are a big business... as is selling college kids all the things they need to occupy the time they might have otherwise been studying. But, sooner or later, the fad will poison itself. People like me will not send their kids to colleges like the ones we attended. Places like St. John's, where students must actually read the classics to earn a degree, will come back into vogue. College will again be expensive, for a minority of students and for educated elites....

"I really enjoy your service, which is honest and enlightening with a very good track record. Even my high school son is now addicted to your newsletters. I understand for value investors it is very powerful to have dividends re-invested in the stock for the compounding effect over a long period of time. For tax reporting purposes, is there an easy way to keep track of such automatic purchases, as over time, it can be a huge number of purchases for each stock? Or is it just the same as for book-keeping for regular purchases of stocks?" – Paid-up subscriber Bob Lin

Porter comment: My broker does this for me. I simply send the statement to my accountant. I don't know how else you'd do it.

"Dear Porter and Gang, corrections like this current one frequently can turn into a buying opportunity. As the dust settles (hopefully soon), I would be interested in which of the many recommendations in the Alliance universe would be considered the best bargains. This could be an opportunity to sell some of the weaker stocks and consolidate into some of the stronger ones." – Paid-up subscriber Don Colbourn

Porter comment: Our latest S&A 16 (our Alliance Model Portfolio) is on the website. These are our best ideas, out of our entire coverage universe. But, despite the sell-off, most of our positions are nearly unchanged... or are even up a bit.

"I am trying to cope with my exasperation over S&A's repeated broad references to 'Florida' real estate which actually reference Miami real estate. Miami is an area unto itself and is no more representative of Florida than Los Angeles or New York City is representative of California or New York State, respectively. Since I am sure you agree that all real estate is local, when you are commenting on Miami, please do us Floridians the favor of restricting your headlines and your comments to 'Miami' and refrain from calling it 'Florida' real estate. I hope you don't think I am quibbling. To return the favor, I won't lump in the fine folks at S&A with the rest of the newsletter crowd. Both favors are not only fair and appropriate, they are well deserved." – Paid-up subscriber Mike Reiter

"I currently work for BP in their construction department in Durango, Colorado. I don't know how familiar you are with this area, but my understanding is that we are sitting on the largest natural gas deposit in North America. BP and the Southern Ute Tribe are extracting the majority of it. BP announced about 5-6 months ago that it would be investing 2.4 billion dollars into this field over the next couple of years, because we just received approval to double the number of wells in this area... which is why they hired me to build them a new 75,000 square foot office building. We are just getting ready to break ground. This was a big milestone for BP in this area and the only way they got approval was that all new wells will be directionally drilled from existing wellpads in order to minimize the impact on the environment by not creating new wellpads. There is additional cost in directional drilling, but it can be offset by the existing pad and infrastructure that is already in place, so it works out pretty good for everyone. Also, since I have worked in both residential and commercial construction in the four corners area, mostly Durango, I can tell you that there are a few pockets of real estate in the U.S. that have been barely, if at all, affected by the real estate downturn. This is such beautiful country with pretty mild weather, that people still want to live here, especially the wealthy from California and Texas that seem to be migrating here." – Paid-up subscriber Nate McEntire

"I am a new subscriber to The 12% Letter, which has a lot of information. However, I only have a small amount to start investing with so I cannot buy a lot of stocks. I was doing options. If you could help me get started I would appreciate it. I do a lot of reading and checking stocks, but by the time I have spent hours on research, I still don't know what to do. Please point me in the right direction." – Paid-up subscriber JMB

Porter comment: Oh boy... That's a big question. I've got three quick answers. First, don't buy options until you've learned to invest successfully for at least five years. Second, buy only the stocks whose businesses you understand and where you believe your capital is likely to be extremely safe. Third, make sure you buy at a low enough price (relative to earnings, intrinsic value) that even if nothing good happens for the company, you can still earn a satisfactory return. (One more thing: read The Intelligent Investor by Ben Graham.)

"Agree with you that Ford won't pull too many Aston-Martin rabbits from the hat! I just returned from doing some work in Dubai, where my client mentioned he was involved in the financing for the purchase of Aston Martin. Note that regardless of what the news agencies report (e.g. BBC: "...sold to a UK-led consortium"), much – if not the overwhelming majority – of the funding came from Adeem Investment Co. While the media goes on about the "revered British luxury name," the world is changing – and they don't seem to notice. Who's Adeem Investment Co, you rightfully ask? Well, the website won't give you much. But look deeper – to the fact they partner with "The Investment Dar." This operation is owned largely by the Kuwait Public Authority of Social Security, and touts a "Diverse shareholder base: over 800 prominent and respected individuals and institutions mainly from Kuwait, Saudi Arabia, United Arab Emirates, Bahrain, Qatar and Oman." Wake up. The shift in assets to the Middle East is unprecedented." – Paid-up subscriber Jeff Woodard

"You asked Porter, so here we go. My e-mail has been flooded by the analysts telling me to jump out of one position after the other. As I am an Alliance subscriber, you can imagine that is a lot of positions. Sure, I'm having some expense in my portfolio, however USG (as an example) is not going bankrupt nor are many of the other companies the analysts are saying to abandon. The 'run to the hills' mindset is disappointing to me. You follow Buffett and other investors as models, yet in the past few days, the analysts have acted more like the overreacting market instead of experienced trader/investors. Almost all of these positions will regain some of these expenses merely from the bounce. At that point, an analysis should be made on whether to continue to hold the position or sell it. Don't tout business fundamentals and balance sheets and all of the other excellent analysis that S&A produces and then 'run to the other side of the boat' i.e. the old analogy about fishing and markets. I did notice that I have not received any 'bail out' notices from you or Sjuggerud over the past few days." – Paid-up subscriber Tommy Hiett

Porter comment: We serve the interests of many different investors, with different risk tolerances and different objectives. It makes sense to bail out of speculations (like my speculations on USG and AHM) quickly when they don't work out. On the other hand, with long-term investments, like my Lexmark recommendation, we're not bailing out at all.

Regards,

Porter Stansberry

Baltimore, Maryland

The Panicking Investor

By Ian Davis

Last week was a nightmare for most investors...

The Dow Jones Industrial Average closed above 14,000 for the first time ever on July 19. Then, just eight days later, it plummeted to 13,265... a fall of 5.2%.

Of course the Dow Industrial Average wasn't the only thing that got crushed last week. According to Fortune, "The total stock market (as measured by the Dow Jones Wilshire 5000) lost a cool $1 trillion in value."

Buying when everyone is optimistic – like they were on July 19 – almost always leads to short-term losses. Conversely, selling when everyone is panicking – like they are now – is also a quick way to lose some money. You're better off holding or buying.

One way to gauge investor optimism, or pessimism, is with a market-breadth indicator, which measures what percentage of the market is climbing or retreating.

When people become overly optimistic about the future of the stock market, they tend to buy everything... and as a result, a very high percentage of stocks rally. On the other hand, when people become overly pessimistic about the future of the stock market, they tend to sell everything, causing a very high percentage of stocks to lose ground.

The Market Is Oversold

Last Thursday, only 9.5% of NYSE stocks advanced. This is the fewest number of rising stocks in more than three years. Friday was better – registering 31.4% of stocks advancing – but still within the bottom 20th percentile, historically.

These oversold conditions are often great short-term buying opportunities for investors.

The chart below shows the percentage of advancing stocks in the NYSE. As you can see, buying when the market enters oversold territory has led to some great short-term gains in the past... even in the middle of bear markets.

The Market Fell into Oversold Territory on Friday

And as you can see in the following table, investors can make some modest returns after an oversold reading:

Conclusion

I'm not making any predictions on the long-term direction of the market. But, given its extremely oversold state, I'm betting that stocks are in for a rally over the next one to three months.

Good investing,

Ian Davis

July 30, 2007

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