The S&A Digest: Viva Mexico?

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(Top 10 highest-returning open positions across all S&A portfolios)

As of 07/01/2013

Ferris does The Digest… Ian Davis no le gusta Mexico… Pickens picks drillers… Fact check for FedEx… Hedge funds drop global warming…

Editor's note: Porter's on vacation this week. Extreme Value editor Dan Ferris will be taking the Digest reins. We hope you find him every bit as provocative as Porter.

 Oil tycoon T. Boone Pickens is putting his money in oil drillers. Pickens, along with many other oil investors, sees the lengthening waitlist for rigs (currently three years for more advanced setups) and steadily rising rental rates as reasons why drillers will outperform producers during 2007.

Pickens is probably right about the drillers… There hasn't been enough investment in oil and gas infrastructure over the past decade or two, from the wellhead to the gas pump. I've recommended a driller in our new S&A Penny Letter, and a few oil and gas companies in Extreme Value.

 Dear Ken Fisher: If you're ever in southern Oregon, you're welcome at the Ferris house. Fisher is the son of investing legend Phil Fisher and the manager of $35 billion as CEO of Fisher Investments. Much to his credit, Ken Fisher has correctly identified global warming as an investment "bubble" and "social short-term craze." Global warming's bubble status was confirmed last night at the Academy Awards ceremony, when Al Gore's paranoid film, An Inconvenient Truth, won the award for best documentary.

 Some of the smartest money in global warming stocks is on the way out. Hedge funds D.E. Shaw & Co., Tudor Investment Corp., Citadel Investment Group LLC, Caxton Associates LLC, SAC Capital Advisors LLC, and Pequot Capital Management Inc. have all reduced their stakes in solar-power and ethanol companies. Together, these funds manage $86 billion. Short-selling of alternative-energy stocks climbed 45 times faster than the average for S&P 500 members.

 Hang onto your wallet. UBS and JPMorgan are among those now offering investors an alternative to hedge funds. These "long-short" funds charge an average of 2.2% and are open to investors with as little as $1,000.

This sounds like a huge rip-off. No one who only has $1,000 to invest should ever pay a 2.2% management fee – ever. And no one with only $1,000 to invest should ever sell short. Until you've got so much money you don't know what to do with it all, your stock portfolio should be long only.

 Strong demand for biofuel feedstocks, like corn and soybeans, is encouraging farmers to plant these crops instead of grains… like barley. This switch has led to an increase in the price of barley, up 85% since last May. If the trend continues, the price of beer, the cost of which is 7%-8% barley, may rise over the long term. I hope the price of Samuel Adams Boston Lager doesn't go up.

 New highs: Anglo American (AAUK), American Real Estate Partners (ACP), AutoZone (AZO), Excelon (EXC), FLIR Systems (FLIR), Gabelli Dividend & Income Trust (GDV), KLA-Tencor (KLAC), Kodiak Oil (KOG), Macquarie Global (MGU), Southern Copper (PCU), Silver Standard Resources (SSRI), Allegheny Tech (ATI).

 A surprisingly light load in the mailbag today. Rants and damnations have instead been replaced by… praise. Hopefully we can continue to "stir the pot" while Porter's away. Tell us how you really feel at feedback@stansberryresearch.com.

 "[Dr. Eifrig's] latest comments about the integrity of modern U.S. doctors are very accurate in my opinion. Most are well intentioned, but either too mentally lazy, too arrogant, or too afraid (of being sued) to look beyond what they learned in med school and what the drug companies et al 'teach' them. Modern medicine is one of the truly great failures of our society, causing as much damage as is 'cured' (antibiotics excepted), at ridiculous costs." – Paid-up subscriber Lee Hodges

 "I subscribe to 2 services and find the analysis to [be] rational and well thought out. But your constant bombardment of solicitations to sell me some 'great deal' for my own good really rubs me the wrong way! They come across as somewhere between 'snake oil salesman-like' and bait and switch! And receiving them fills me with an urge to cancel all subscriptions to your research, which would be to my detriment. Keep your focus on research, which you do very well. And lay off the condescending ads, which talk to us like we are either simpletons or lemmings!" – Paid-up subscriber John Vincent

Ferris comment: Your praise for our research is much appreciated, but let me get this straight… By your own reckoning, reading our marketing – and buying our products – has turned out rather well for you. And yet, you want us to stop sending you our marketing pieces. If something turns out well for you, why would you want to stop doing it? If there's something in your inbox you don't want to read, I have a foolproof method for handling it: Delete it.

 "Despite the pejorative comments of some readers, Steve Sjuggerud's methodology is sound and time-tested. His latest unpopular foray is vintage Steve – we recently saw a chart of Japanese real estate courtesy of GaveKal research, which showed the long declining trend line being broken – just barely, but broken… It is precisely these relatively long bull – and bear – celebrations and swoons that cause opportunity. Bravo for Steve." – Paid-up subscriber Jim Pursley

Ferris comment: If I didn't work here, I'd just read True Wealth and swear by every word.

 "[In Michael Crichton's novel, State of Fear], he makes the extremely interesting observation that the explosion of environmental hysteria coincided exactly with the fall of the Berlin wall. His character observes that governments use fear as a means of justifying violations of the rights of the people, and that when the fear of communism was gone, it had to be replaced by some other fear." – Paid-up subscriber Philip Hoff

Ferris comment: Crichton is right. Sounds like a good book. I'm going to buy a copy and read it on vacation next month.

 "I am a True Wealth subscriber. I read with great interest your article on General Motors and how you feel they are going to be bankrupt in three years or less. As a recent retiree of Ford Motor Company, I am wondering what you think about Ford – are they in a similar situation?" – Paid-up subscriber Del Moore

Ferris comment: Last year, I heard Sean Egan of Egan-Jones ratings agency speak at the Grant's Interest Rate Observer conference in New York. Egan said that, if you handed the financials of Ford and GM to a finance student and didn't tell him what companies he was looking at, he'd tell you they were both bankrupt.

I don't know what will happen to either one. As an investor, it is completely unnecessary to predict anything about them (or much else, for that matter). They're in the worst financial shape, and that's all I need to know.

 Finally, in the mailbag today, "ccuthbert" says we need to do some fact-checking, and he's right. Last week, we wrote that Fred Smith, founder of Federal Express, "got a C in his Harvard MBA class because his professor said his business plan (for FedEx) was impractical." This is an oft-told tale. I've wrongly told it many times myself.

The facts are as follows: Smith went to Yale, not Harvard. And he was an undergrad, not an MBA candidate. He never went to grad school because he went to Vietnam instead. Smith doesn't remember what grade he got on his paper, but admits it wasn't very well thought out. And the paper wasn't a business plan for FedEx. It was about the inadequacy of passenger route systems to properly serve airfreight shippers. The idea for FedEx came about six years later, when Smith was running an airfreight outfit in Arkansas. He noticed that it was nearly impossible to ship something by air in less than two days. You can find the whole story, including an article by Smith himself, at www.fedex.com.

Regards,

Dan Ferris

Medford, Oregon

Viva Mexico?

The Mexican stock index, the IPC, is flying high. The index has soared by 70% over the last eight months – making it one of the best-performing markets in the world. According to CNBC, Mexico's economy is growing at its fastest rate in more than six years, the country's homebuilding sector is red-hot, and foreign direct investment rose by some 6% last year to nearly $19 billion.

So is Mexico overbought and due for a correction? CNBC doesn't think so, claiming, "Few predict the market, or the economy, will stall, even if those in the U.S. stumble."

However, I wouldn't go putting your money into Mexico just yet.

As contrarians, we see Big Media stories like these as bellwethers of market tops. Let's take a look at what's wrong with Mexican stocks…

VALUATION:

A couple of weeks ago, I wrote that emerging markets were due for a correction. Over the last eight months, emerging markets have performed exceptionally well, gaining 41%. However, this has made the emerging markets index very expensive. Mexico, after increasing by 70% over the same time period, is even more expensive than its emerging-market peers.

As the following chart shows, Mexico's price-to-book value (as measured by DataStream's Mexico Index) is currently at 3.22. This is more than 100% above its median level over the past 17 years and is higher than the price-to-book value of DataStream's U.S. Index.

SENTIMENT:

Sentiment is always the most bullish right before a market top. This has been true in every financial market throughout the age. Right now, it's true of Mexico.

As you can see in the following chart, when people are extremely bullish about the future business situation in Mexico, the market tends to underperform in the following six to 12 months. Conversely, when people are overly pessimistic, the market tends to outperform. Right now, this indicator is telling us to be cautious.

CONCLUSION:

For the same reason that I didn't recommend shorting emerging markets, I'm not going to recommend shorting Mexico… yet. The trend in both Mexico and in the broader emerging-markets index is still strongly up. Wait until this trend reverses before trying to profit off the coming correction. In the meantime, I recommend caution when it comes to these overheated markets.

Editor's note: Ian Davis, our resident quant, has been making recommendations in The Digest since November. Below, you'll find his track record.

Good investing,

Ian Davis

February 26, 2007

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