The other day we said most stock traders have poor math skills. We said this upon watching the shares of companies like Macerich soar. Consider MGM, which reached a current valuation of $1.5 billion. This despite the company's enormous $13.5 billion debt load (which it cannot afford to finance) and its unknown future obligations to CityCenter – a $70 million payment for which is due Monday. Private-equity firms, on the other hand, tend to have excellent math skills. And that explains why one such firm, Colony Capital, just broke off talks with MGM. And these talks were what led to the stock's rally.
We don't know how far the shares will fall when the market reopens on Monday, but we do know what the bond market thinks the stock is worth: zero. MGM's bonds are trading around $40. These would have to pay off at par ($100) for the stock to be worth anything. To say that's very unlikely would be like saying the Pope probably isn't Jewish.
In our experience, the bond market is far more efficient than the stock market. Bond investors focus on the likelihood that a company can repay its debts. They analyze the cash-flow statement and the balance sheet. Of the three common financial statements, these two leave the least room for imagination. Cash can be counted. Assets can be priced.
Stock investors, on the other hand, tend to focus on something called "earnings," which are reported on the income statement. Earnings are fictional. They are a product of modern accounting, most of which seems to have been designed to sucker naïve investors. If financial statements were genres of books, you would say the cash-flow statement is an honest memoir, the balance sheet is a well-researched biography, and the income statement is fantasy science fiction.
Goldman Sachs, for example, claimed to have "earned" more than $20 billion over the last three years, but actually lost more than $100 billion in cash. Which do you think is likely closer to reality? Or look at MGM. MGM claims to have $3 billion in "earnings" over the last three years. But looking at its cash flows, it seems like it really lost about $2 billion, which is why it was forced to add yet another $1 billion to its debt load.
Just make a note and stick it on your computer screen: Don't buy stocks that have wide and continuing discrepancies between what they report in earnings and what they make in cash. Don't buy stocks that add, continually, to the amount of debt they carry. And don't buy stocks whose bonds are trading at a huge discount from par.
A study that's coming out in the Journal of Monetary Economics written by two professors and an economist at the Fed proves what I've learned from experience: The bond market is far better at predicting the economy than the stock market. The bond market is smarter. According to this study, changes in the market for corporate bonds with a maturity of 15 years or more were incredibly accurate in predicting big changes to economic growth and unemployment, a year before they occurred.
What's the corporate bond market saying now about the economy next year? Production will fall another 17%, and 7.8 million additional jobs will be lost.
One more thing about the importance of understanding a company's financial position... In a recent Forbes interview, value-investing legend Marty Whitman says "the importance of creditworthiness in equity investing" is the most valuable lesson he's ever learned. And he's bullish on the future, noting "the opportunities of a lifetime." Whitman says he's pretending it's 1932... and he wouldn't want to be selling in 1932. "Values in well-financed situations have never been greater in my lifetime than they are today."
Wells Fargo soared more than 30% yesterday after the company announced expected profits of $3 billion for the first quarter – almost double analyst estimates. Mortgage originations doubled from fourth-quarter levels to $100 billion – and three quarters of those were refinancing. Warren Buffett, Wells' largest shareholder with 290 million shares, made $1.4 billion on the move. Berkshire shares jumped nearly 4%. Wells' recent success is exactly the reason Buffett said on CNBC last month:
The spreads have never been wider. This is a great time to be in banking, you know, if you just get past the past and they are getting past the past. I mean, right now every time a loan is made to somebody to buy a house – and we're making, you know, making millions of loans – four and a half million houses will change hands this year out of a total stock of less than 80 million. So those people are making good mortgages. You want those assets on your books and you get a great spread in putting them on now. So it's a great time to be in banking, but you do have to get past this past.
The government has done everything in its power to lower borrowing costs, pushing mortgage rates to the lowest in more than 30 years and cutting banks' borrowing costs to nearly zero. The government's actions spurred mortgage activity and created a perfect lending environment for banks... the spreads are huge. We're making money on the trend for our readers by recommending mortgage finance companies Annaly (NLY), Hatteras (HTS), and Chimera (CIM). We hope you've profited from our work.
New high: Genomic Health (GHDX).
In the mailbag... Cries for mercy. Some of you have heard enough about the problems our country is facing. Just sugarcoat it, you seem to say. No way. If you'd rather hear a candy-apple version of the world's financial matters, tune into Brian Williams. He's everything we're not: Handsome, well spoken, polite... and a damn fool. Send your comments here: feedback@stansberryresearch.com.
"What the f^&$ is this... ? I subscribe to your service for investment advice, and I could not care less about your political leanings. You remind me of that miserable bastard ghbush with his 'l' word. You forget that those Bush sons of bitches got us into this mess." – Paid-up subscriber Milt
Porter comment: And we couldn't care less about your political leanings either, Milt. Nor did we vote for or encourage the madness of King George. Our recent focus on politics is simply because we care about our own wealth, your wealth, and the wealth of our country. OBAMA! and his Democratic friends in Congress are taking us down a path certai
n to bankrupt all of us. The Fed is printing money faster than at any time in the history of our country. OBAMA! plans to expand the national debt by 100% in eight years – something that's never been done before except in times of war. And these debts will come due just as the government's various entitlement programs finally go bankrupt. On top of this disastrous fiscal policy, the Democrats seem determined to push through a so-called "cap and trade" plan to tax carbon emissions...
What most people don't realize about this plan is it's actually the largest tax increase in American history. Says Democratic Sen. Ben Cardin, "It's the most significant revenue-gathering proposal of all time." Current estimates show a cap and trade regime will add $500 billion to $1 trillion to the government's annual revenues – an amount equal to roughly 50%-100% of all the income taxes collected each year!
Taxing electricity at these rates, plus mandating that 25% of all electricity come from "alternative sources," (which doesn't include nuclear power), plus regulating all home appliances, plus making it against the law to trade in incandescent light bulbs... It's insanity. These new taxes and regulations will destroy our economy. I'd bet less than 10 senators understand the incredibly important role electricity plays in our economy: There's a perfect correlation between electricity production and economic growth. Watching the government bankrupt itself with unprecedented new debts, while at the same time shooting our economy in the face with a huge new tax on electricity, should scare the crap out of every American.
And these fears ought to apply equally to Democrats or Republicans. If you were trying to devise a political plan to destroy the country, this is the route you'd take: make it harder than ever before to produce anything, devalue the currency, and raise taxes by 50%.
"So is the 400 Club going to be available to anyone that is willing to pay the price of admission or will admission be based on someone willing to pay the price of admission + an invitation based on some sort of pre-screening process?" – Paid-up subscriber Sean Brown
Porter comment: Right now the idea we're pursuing is a nonprofit, global club that serves the interests of likeminded and very wealthy people – The 400 Club. We're in the process of organizing the launch package, which will feature several "planks" – including global asset management and wealth protection, high-end travel resources, access to elite money managers (audited, by the way), lawyers, accountants, and other kinds of advisors.
We are also building an online networking function – a kind of Facebook for wealthy people who value privacy. We also plan to organize several meetings each year and some kind of club newsletter that will report on the activities of the members. As a nonprofit entity, the club will add benefits as membership dues are funneled back into the club. We envision charging $20,000 to join the club and $5,000 per year in dues for charter members – with these fees increasing substantially after the first 200 members join. We're seeking a very well-known and trusted financial executive to be the club's chairman, and we're looking for charter members to help us build out the club's benefit package. Most of all, though, we want to create a real community – a group of people who share the same basic ideas, values, and needs. The world's rich are under attack by the world's governments. Hopefully, using the power of the Internet and the joint resources of the club's membership, we can offer a powerful tool to help individuals retain their wealth and freedom. If you're interested in receiving information about The 400 Club, let us know.
"Back in 1989 my wife and I quit work sold the house. We got on our small sailboat and went down the Cumberland, Ohio, and Mississippi river and out to sea. We were gone sailing for six years. In that time we visited many countries several were socialist. The people in these countries were great but the oppression they lived under was terrible. Also many of the ports and cities we went into, had watchtowers everywhere. It seemed the main occupation was watching people. I will never forget a Russian talking about how hard it was to get parts for their terrible car and saying it must be really bad in the US with so many different brands and we only have one brand." – Paid-up subscriber JPW
Porter comment: Makes you wonder what that wall they're building along the border in Mexico is really for, doesn't it?
"Just wanted to say, The Put Strategy Report and its guidance and training have provided me with a whole new and unexpected means of income from last October on. Using the technique, I have branched out to a number of prudent put sales on my own, of short-intermediate-to long-term durations... I have not had time to break out net profits of Put Report recos from all those that I have done, but, combined with covered call recos by Dyson and you, it has definitely resulted in significant monthly income... When prudently implemented this is an ATM machine which I know others would venture if they would try it out. I never would have ventured this without your (and Clark's) training. Thanks much and please keep it going." – Paid-up subscriber Kenton Burns
Porter comment: We knew when we started our naked put selling advisory that very few subscribers would consider using it – and we were right. But we also knew the strategy could literally change the lives of those who took the time to read it and understand it. In short, this strategy allows you to pick the price you would like to pay for a stock – and get paid for agreeing to buy it at your price... whatever price you've chosen.
Using this strategy, you can either make a solid income or you can simply buy stocks at far better prices, which will increase your capital gains over time. And we're currently knocking $1,000 off the subscription fee. To learn more, click here.
Regards,
Porter Stansberry
Baltimore, Maryland
April 10, 2009