Wednesday, September 28, 2011
In Friday Digests, I always do my best to teach you something new about finance... something you're unlikely to learn on your own… something your broker would never mention... something valuable... something that gives you a better "toolbox" as an investor.
It's funny that I continue to write these messages because I don't believe in teaching. Or as I like to say: There is no teaching. There is only learning. Few subscribers actually want to learn anything. It's a wonderful thing to be confident about your ability to invest successfully... to always know how take money out of the market in any environment. What I'm really trying to do is to broaden your horizons and inspire you to learn more about finance. Having access to this knowledge has greatly enriched my life.
Take the short positions in my newsletter, for instance. Since the market peaked on April 29, I've recommended seven short sells against only two long positions. That means, while most people were losing money in stocks this summer, we've been able to make a lot of money – about 22% on average for each position. And all the recommendations have been profitable.
Did I know exactly when the market would peak? No, of course not. Do we make money on every single short recommendation? No, of course not. But… as you watched the market turn over this year… it didn't take a rocket scientist to see why adding short positions made sense. If you're familiar with shorting stocks, employing this strategy was simple and kept you in the market this summer. But if you've never tried it… if you don't understand it… you were probably left absorbing losses with no good way to hedge.
So if you're a new subscriber, I urge you to see what I've written about buying discounted corporate bonds, selling options, and the importance of having access to the downside of the market, via selling stocks short. Looking at the various gauges of market volatility (the VIX is now over 40!), it's probably a good time to look carefully at selling some options. I firmly believe that if more of our subscribers understood these financial options – bonds, shorting stocks, selling options – they would be unlikely to ever simply buy stocks again.
Happily, I think we've made some progress. Paid-up subscriber John Howlett wrote to me this week…
I wanted to echo a comment that Porter made a while back in the Digest concerning Mike William's True Income (discounted corporate bonds) and Doc Eifrig's Retirement Trader (which focuses on selling option to generate income) being two of your best newsletters. The comment stuck with me because I had come to the same conclusion probably about a week prior...
When I first subscribed to one of your newsletters about three years ago, I made mistake after mistake – wrong position sizes, lack of trade stops, buying leveraged short funds to try to time the market, lack of discipline, doing too much, etc. If you can name it, I did it. The funny thing is that I considered myself a conservative investor... yet somehow these things "happened." In any case, True Income is fantastic. Not much needed except to be patient and to buy the bonds at a good price… His calls on Global Industries and Western Refining doubled my investment in them – safely.
I had seen where Porter had several times mentioned the power of selling options – particularly puts. Not buying options, but selling them. It only took a couple of trades with Dr. Eifrig's principles to see just how right this was. In just a few weeks, I understood enough to expand his ideas to other stocks – mainly with Dan's World Dominators – putting together a spreadsheet to keep track of the option and stock together and treat them as one position.
It was stunning to see that with careful work, a person can make 18%-20% per year – or more – selling options while reducing risk. On market down days, I'm looking to sell puts. On market up days, I'm looking to sell calls. Bottom line... I have learned tremendously from these guys. My personal opinion is right along Porter's on this one. These two newsletters are gems – your readers that don't use them are missing out.
Let me emphasize... John Howlett is not an employee or a relative. We didn't solicit his comment in any way... And we didn't edit his comment for anything other than length and clarity. I say so because I understand there is a tremendous amount of cynicism and skepticism in the newsletter subscriber community – and rightfully so.
The simple truth is... the sophisticated strategies found in our publications True Income and Retirement Trader make these newsletters difficult to sell or even to explain to novice investors. Subscribers must be willing to learn. And most people are not. It's simply up to you. Try these products – along with shorting stocks via my newsletter (Stansberry's Investment Advisory) – and see if it doesn't change everything about your outlook on investing. I know it will. But I also know most people will never, ever take the first step.
In today's Digest, I'm going to return to the unfolding global banking crisis. I know, I know... many of you are tired of reading about it. A longtime reader – probably the first subscriber I ever gained – complained to me this week via e-mail that he doesn't even read the Digest anymore because he is so tired of my doom and gloom...
I used to NEVER miss an issue because I was sure I'd learn something useful and they were exquisitely smart in some sort of truncated way… Now I feel like I'm getting an ongoing macro analysis of the world economic crisis… The truth is that I often glance at the Digest now and then delete them… I think I read this stuff for wit and attitude more than for his analysis… since your analysis is pretty much the same as it's always been.
He's right, of course. If you go back and read my March 2010 issue of Stansberry's Investment Advisory – "The Greatest Danger American Has Ever Faced" – you'll see that I specifically warned about the huge losses facing Europe's banking sector 18 months ago. I didn't believe these losses could be financed, given the perilous state of Europe's sovereign creditors.
To give a specific example, I picked Italy's UniCredit, because it is the direct predecessor of Kreditanstalt, the Austrian bank whose failure in 1931 knocked Europe and eventually America, off the gold standard.
Today, UniCredit is the largest creditor to Eastern Europe. It owns, for example, Bank Pekao, Poland's largest lender. It generates about half of its profit from Ukraine, Hungary, Romania, and Slovakia. JPMorgan estimates loans to Eastern Europe will generate roughly $40 billion of losses by the end of 2010. And who will bail out UniCredit's depositors if it fails? The Italian government? It can't. It is already struggling with enormous deficits and a debt-to-GDP ratio more than 100%. The rules of the European Monetary Union won't allow Italy's government to add that much more debt to its balance sheet. So what will happen…? I believe the crisis that began with subprime mortgages in 2008 will continue to spread until the world's sovereign credits collapse and the global system of paper money fails. – Stansberry's Investment Advisory, March 2010
Given that outlook... it's not surprising that most of what I've written since then has been a continuation of these warnings. My monthly titles since then include: "Hungary Matters," "The Worst Is Yet to Come," "Risks of a Global Famine," "The BIG Collapse in Bonds," "Time Is Running Out," "For Whom The Bell Tolls," "The Day the Dollar Dies," "Phase III of the Monetary Crisis," and last month's "Europe's Breaking Point." Clearly, I've been hitting people over the head with the message.
And for some people, the message has gotten old... They're tired of reading it. Perhaps they didn't take action sooner to protect themselves... Or perhaps they believe the tide is about to turn, and they want to know what to do next... Or perhaps they're simply tired of reading bad news. Sorry. I don't make the news. I just report it... and I continue to believe these risks are so serious that nothing else is as important. Not even close.
So... here's what will happen next. Soon, Greece will default. This will begin a chain reaction of European bank failures, because most banks in Europe have only written off a small portion (21%) of the value of the Greek bonds they hold. French banks are particularly vulnerable right now. This, in turn, will cause banks to stop lending to each other out of fear.
It will also lead to big losses in the commercial paper market. That's how the crisis will spread to the U.S. – our money-market funds still hold roughly 42% of the assets in loans to Europe's banks. Companies with exposure to European financial assets (like GE) and those that depend heavily on the commercial paper market for funding (like Capital One) will see their share prices plummet. As the global economy stalls and then moves into recession, unemployment will worsen… and political tensions will greatly increase. I expect large-scale civil unrest in both Europe and the U.S.
In the short term, commodities are also likely to fall sharply. The crisis is nearing a breaking point. Europe represents the world's largest economic area. I expect oil will fall at least in half from its peak. You could see silver fall, temporarily, by maybe another 30%. Gold could fall by maybe 25% from its peak. Base metal and energy commodities – stuff like copper and coal – will get crushed, like they did in 2008. In short, this is Europe's turn to have a Lehman Brothers-like banking collapse. Only this time, it will involve dozens of huge banks and several different countries, all of which have different ideas about how the crisis should be solved.
And that means it will probably be a longer and deeper crisis than Lehman Brothers. But... sooner or later... we're going to see a massive reversal. The Fed will step in to support the ECB, and a tremendous amount of new euro will be issued. I expect the euro to fall to parity – 1:1 – with the dollar before this crisis is over.
The hard part will be knowing when the time comes to jump back into blue-chip stocks, strategic commodities (like oil shale assets), discounted corporate debt (which I believe will get much, much cheaper from here), and strategic metals (like gold, silver, copper, and iron). During the Lehman crisis, the peak interest rate spread between junk bonds and U.S. Treasurys was around 22%. The spread on European bank debt could get at least that high, as will most of the sovereign debt of the peripheral nations. And we're just not there yet.
Is there a chance I'm wrong? Is there any realistic way to solve this crisis without a Greek default and a European banking crisis? I don't see how. Germany is the only truly solvent, large European country left. And the German voters continue to hand the ruling party loss after loss in local elections, specifically because the public is almost unanimously against Germany bailing out the rest of Europe. Likewise, the German representative of the ECB resigned last week out of protest against any future quantitative easing, aka money-printing.
What should you do while this crisis continues to deepen? The same advice I've been giving since March 2010. If you're sophisticated, you want to build a large book of short sells to hedge your stock market exposure. You should own at a minimum 15% of your assets in gold and silver. If you're unable or unwilling to hedge your portfolio, I recommend putting half your portfolio in Treasury notes (via the iShares short-term Treasury Bond fund, SHY) and half your portfolio into gold (via the iShares gold fund, GLD). Doing this 50-50 split between gold and the U.S. dollar is the only true way to go to "cash," given the tremendous uncertainty in the future of the global paper money system.
I wish I had better news… or a more promising strategy I could endorse. But as always, I've got to write what I believe. I hope you'll remain patient with me and continue to subscribe. When the market turns, I'll get you back in... just as I did in November 2008 through May 2009.
Cheap stocks are suddenly abundant. The S&P Composite 1500 index of large, midsize and small U.S. companies has lost 12% in three months. More than 300 of its members now have price-to-earnings ratios in single digits, suggesting a discount of more than one-quarter to historical levels.
That alone doesn't make these stocks bargains. If earnings in coming quarters prove much lower than expected, today's P/E ratios will have misled. The task for investors is to figure out which companies are both modestly priced relative to forecasts and likely to meet or exceed those forecasts.
One tool professional investors use to predict that is past earnings volatility. Companies with relatively smooth earnings histories — a low standard deviation of quarterly earnings, in statistical parlance — are more likely than others to deliver the same in coming quarters.
But this tool is of limited use now, because the past five years have produced chaotic results for much of the market, and traditionally stable industries now face challenges. Food makers must deal with crop inflation, soap and toothpaste firms are battling a shift in shopper preference to discount brands and even some utilities are seeing a drop in electricity usage. Some companies in these industries will report stable earnings over the next year, but perhaps not all of them.
So here are two ways to tell which firms are reliable. The first is to look for a recent dividend increase. That puts more cash in shareholder pockets, but just as important, it signals that managers are confident about future results. After all, no company wants to raise its dividend only to find the new payments unaffordable in the coming year.
The second is another statistical clue: a tight clustering of the earnings estimates issued by different analysts. Three decades of research, including recent studies by Anna Scherbina, now at U. C. Davis, show two important things about estimate dispersion. First, tightly grouped estimates are more likely than scattered ones to precede an upside earnings surprise. Second, stocks with clustered earnings estimates tend to outperform those without.
One theory on why this is so has to do with the earnings guidance that companies provide to analysts. Firms with good news to report tend to be more forthcoming with details than firms that are struggling, the thinking goes.
The 10 stocks below have modest P-E ratios and healthy dividend yields. They've also raised payments over the past year and have earnings estimates that show relatively close agreement among analysts.
* Based on forecasted EPS for current fiscal year
Data as of Sep. 22, 2011
Source: Thomson Reuters
A new report from the Office of the Comptroller of the Currency reveals U.S. banks have $249 trillion of exposure to derivatives — futures, forwards, swaps, options and assorted credit instruments. Among those are the credit default swaps they wrote for the European banks, whose considerable risks we’ve documented extensively.
Four banks alone account for 94.4% of that total.
Stocks are volatile, the economy is stagnant, and corporate pensions and Social Security seem less viable by the day. One might expect such a dismal confluence of events to jolt aspiring retirees into financial-planning overdrive, furiously making budgets, cutting spending and salting away every spare nickel.
Yet many Americans are responding to the market and economic malaise by putting their heads in the proverbial sand. Half of U.S. workers who are at least 45 years old haven't even tried to calculate how much they will need to save to live comfortably in retirement, according to a March study by the Employee Benefit Research Institute.
Others are shelving retirement dreams because they are paralyzed by fear. According to EBRI, 20% of employees say they intend to retire later than they had planned, for reasons ranging from the slowing economy to worries over the future of Social Security.
Even wealthier people are nervous. Two-thirds of "affluent investors" with at least $250,000 in investable assets surveyed in June were concerned that their retirement stash won't last throughout their lifetimes, up from 57% in December, according to Bank of America Merrill Lynch.
"People are frozen because they don't know which way to go," says Jeannette Bajalia, president of Petros Estate & Retirement Planning in St. Augustine, Fla. "Anytime there's ambiguity, it immobilizes them."
The good news is that there are ways to fix derailed retirement plans. Among the essential tasks: talking honestly with your spouse, planning realistically for health-care expenses and rethinking your retirement age and Social Security assumptions.
The first step is looking beyond the current market realities of volatile stocks, low-yielding bonds and slow economic growth — and having the fortitude to continue taking measured risks. (more)
Investors have renewed their obsessing over the risk of sovereign default, as fear creeps back into the market that contagion will lead to a replay of the financial crisis and the return of a recession. While sovereign debt defaults are frightening, they are actually quite common and may not lead to the worst-case scenario that many are expecting. Here are seven facts about sovereign debt defaults that might surprise you.
The PIIGS countries - or Portugal, Italy, Ireland, Greece and Spain - are on everyone's watch list as having the greatest risk of sovereign default. These five countries have a mixed historical record of sovereign default over the last 200 years, with Ireland never defaulting on its obligations and Italy only once during a seven-year period in World War II.
Portugal has defaulted four times on its external debt obligations, with the last occurrence in the early 1890s. Greece has defaulted five times and has spent a total of 90 years in this status since achieving independence in the 1820s.
Spain holds the record on the PIIGS list and has defaulted six times, with the last occurrence in the 1870s. If you extend the date range back another three centuries and start in 1550, the default count rises to 12.
There are a number of countries that have pristine record of paying on sovereign debt obligations and have never defaulted. These nations include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland and England.
Don't think that these countries skated through the last 200 years without financial problems, because endemic banking crises were a common occurrence. England has suffered 12 banking crises since 1800 or an average of about one every 17 years.
3. The U.S. Has Defaulted on Debt (Technically Speaking)
Although the conventional wisdom is that the United States has never defaulted on its sovereign debt obligations, there have been some instances that may qualify under a strict and technical definition.
In 1790, the United States passed a law that authorized the issuance of debt to cover the obligations of individual states in the union. Since some of this new debt didn't start paying interest until 1800, some purists consider this a technical default.
Many issues of U.S. government bonds issued prior to the 1930s contained a gold clause under which bondholders could demand payment in gold rather than currency. In 1933, President Roosevelt and Congress decided that this promise was against "public policy" and obstructed the "power of the Congress" and ended this right. The issue was litigated and ended up before the Supreme Court, which ruled in favor of the government.
In 1979, the government could not make timely payments on portions of three maturing issues of treasury bills due to operational problems in the back office of the Treasury Department. These payments were later made to holders with back interest.
4. Ground Zero
Ground zero for modern sovereign debt default seems to be in South America and Central America where Venezuela and Ecuador share the dubious honor of 10 defaults each.
Brazil, which today is one the fastest growing of the emerging economies, has defaulted nine times, while Costa Rica and Uruguay have disappointed foreign investors nine times as well over the last 200 years.
Another oasis of financial strength today is China, which has trillions of dollars in reserves and suffered only marginally during the recent recession. China has defaulted only twice, both times during times of external and internal conflict.
The Western Powers sometimes reacted with military force when a country decided not to pay back money that was borrowed. In 1902, Venezuela refused to pay on its foreign obligations and after negotiations failed to resolve the issue, Britain, Germany and Italy imposed a blockade on Venezuela.
The conflict escalated quickly and a number of Venezuelan ships were sunk or captured, ports were blocked and coastal areas were bombarded by the Europeans. The U.S. eventually intervened to mediate and after several years of negotiation Venezuela combined its outstanding debt into a new issue, added back interest and made payments until the issue matured in 1930.
Some sovereign defaults are intentional and are not necessarily due to a lack of financial resources. In February 1918, the new government in Russia repudiated all debt issued by the previous Tsarist government. Bondholders have long memories and this default officially lasted until 1986, when Russia settled with British holders of this paper. In 1997, an agreement was reached with French bondholders as well.
The Bottom Line
Sovereign debt default is a terrifying thought to many investors and the dread is only amplified in the current environment of financial gloom that pervades the market. Investors that examine the issue more rationally, and in the context of the history of such events, will realize that the global financial system has seen this before and survived.
If dollar-dumping turns from a trickle into a flood, look out. Exploding prices (aka exorbitant inflation) resulting from the devaluation of the dollar will compound the problems we saw in 2007–2009. Catastrophe will come when everybody realizes that the dollar is an "IOU nothing." That's the downside in the decade(s) ahead, according to Casey Research Chairman Doug Casey. But an optimist at heart, in this exclusive interview with The Gold Report, Doug also identifies some reasons to be hopeful.
Doug Casey: Both, but in sequence. One thing that's for sure is that although the epicenter of this crisis will be the U.S., it's going to have truly worldwide effects. The U.S. dollar is the de jure national currency of at least three other countries, and the de facto national currency of about 50 others. The main U.S. export for many years has been paper dollars; in exchange, the nice foreigners send us Mercedes cars, Sony electronics, cocaine, coffee—and about everything you see on Walmart shelves. It has been a one-way street for several decades, a free ride—but the party's over.
Nobody knows the numbers for sure, but foreign central banks, and individuals outside the U.S., own U.S. dollars to the tune of something like $6 or $7 trillion. Especially during the recent crisis, the Fed created trillions more dollars to bail out the big financial institutions. At some point, foreign dollar holders will start dumping them; they are starting to realize this is like a game of Old Maid, with the dollar being the Old Maid card. I don't know what will set it off, but the markets are already very nervous about it. This nervousness is demonstrated in gold having hit $1,900 an ounce, copper at all-time highs, oil at $100 a barrel—the boom in commodity prices.
Some countries are already trying to get out of dollars, but it could become a panic if the selling goes from a trickle to a flood. So, yes, it's a time bomb waiting to go off, or maybe a landmine waiting to be stepped on. If a theatre catches fire and one person runs out, soon everybody rushes toward the door and they all get trampled. It's a very serious situation.
TGR: If panic erupts on the U.S. dollar, would products manufactured in the U.S. become super-cheap or super-expensive?
DC: They would become super-cheap. Everybody says that devaluing the dollar will stimulate U.S. industry because the products will become cheaper and foreigners will buy them. This is a huge canard everybody repeats and nobody thinks about. Yes, it is true for a while, but if devaluation were the key to prosperity, Zimbabwe should be the most prosperous country in the world as it has already collapsed its currency.
A strong currency is essential for a strong economy. Sure, a strong currency can hurt exporters for a while. But, a strong currency encourages manufacturers to invest in technology, and become more efficient. It rewards savings and results in the growth of capital that's critical for prosperity. A strong currency allows businessmen to buy foreign companies and technologies at bargain prices. It results in a high standard of living for the country, and yields social stability as a bonus. The idea that decreasing the value of currency to stimulate exports is a short-lived, stupid and counterproductive solution to the problem. People seem to forget that while the German currency was rising about sixfold from its level of 1971, and the Japanese yen about fourfold, those countries became the world's greatest export economies. It didn't happen despite a strong currency, but in large measure because of it.
TGR: Given that the U.S. is the world's biggest consuming nation, wouldn't fleeing the dollar create a big consumer vacuum in the international community? Doesn't the rest of the world want to keep up the high level of exports to these U.S. consumers? (more)
The S&P Case-Shiller Home Price Index for July came out today. Here were the two headlines from the mainstream media:
So which was it? Did home prices rise or fall? Technically they are both correct, but each one slanted the information in the way they wanted the story to read. Glass half-full or half-empty?
The truth is more in line with what Bloomberg said and that is that home prices are still falling, the current gains are technical results from the foreclosure problems that lenders have, and that foreclosures will resume and increase shortly and the market will continue to be depressed.
“The enormous supply overhang of existing homes, particularly factoring in all those in foreclosure or soon to be, promises to keep pressure on prices for some time,” Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, said in a note to clients. “We look for further declines to be registered in the quarters ahead, although in all likelihood the rate of deterioration will be nowhere near as steep as that recorded earlier.” [Bloomberg]
Here is what it looks like:
The ten-city index is identical. There are seasonal factors at play here as well (summer having higher sales).
According to the Report:
U.S. home prices, showed a fourth consecutive month of increases for the 10- and 20-City Composites, with both up 0.9% in July over June. Seventeen of the 20 MSAs and both Composites posted positive monthly increases; Las Vegas and Phoenix were down over the month and Denver was unchanged. On an annual basis, Detroit and Washington DC were the two MSA that posted positive rates of change, up 1.2% and 0.3%, respectively. The remaining 18 MSAs and the 10- and 20- City Composites were down in July 2011 versus the same month last year. After three consecutive double-digit annual declines, Minneapolis improved marginally to a decline of 9.1%, which is still the worst of the 20 cities. …
[T]he 10-City and the 20-City Composite Home Price Indices. In July 2011, the 10- and 20-City Composites recorded annual returns of -3.7% and -4.1%, respectively. …
The S&P/Experian Consumer Credit Default indices showed a continuing decline in mortgage default rates, a two-year trend. However, if you look at the state of the overall economy and, in particular, the recent large decline in consumer confidence, these combined statistics continue to indicate that the housing market is still bottoming and has not turned around.