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Weekend Edition

The Best of The S&A Digest
Saturday, May 9, 2009

What a conundrum... The financial world has turned into "bizzaro" world, where everything is suddenly the opposite of what it should be. Bank of America says it needs $34 billion more capital... and the stock jumps 20%. Nearly all of the highly leveraged stocks I've been following have gone way up over the last two weeks...
 
But the rally is odd – stocks are soaring, but bonds aren't moving much. Shares of real estate firm Vornado are up nearly 100%. The stock now yields only 7%. But its bonds are still trading below par and yielding 10%. Why would a rational investor accept a lower dividend yield when a higher bond yield is readily available? I think I know the answer...
 
Consider MGM. MGM's bonds maturing in February 2011 trade at 50 cents on the dollar and yield 51%. Unless this debt is repaid, the common stock is probably worth zero. And yet, equity investors believe the stock is worth more than $3 billion – seven times more than it was worth only two months ago.
 
Or what about our other whipping boy, Capital One? Despite $23 billion in debt, ongoing quarterly losses, and $100 billion in dubious unsecured credit-card assets, the stock has soared – up from $8 to more than $30. The stock market seems to think everything will work out fine. But the bond market isn't so sure. Despite the awesome presence of the U.S. Treasury supporting banks, Capital One's bank subsidiary's bonds maturing in 2011 trade at $85 and yield 11%.
 
What should we make of these big moves in equities – where the biggest gains have come from the lowest-quality stocks? Why would investors suddenly favor equity over debt? It looks like a new wave of inflation hitting the markets.
 
The government's efforts to pump up the money supply and push the economy forward with enormous amounts of fiscal stimulus must be working. With access to the "wall of money," the government has sent into the market, the most leveraged equities have the most to gain. Similarly, the most subordinated part of the capital structure has the most to gain.
 
One piece of advice: If you're going to speculate on the turn from a deflationary environment to an inflationary one, buy the short-term bonds of these companies trading at a discount to par. You will likely make more money in the bonds than in the stocks. You can read more about why I expect you'll make far more money in bonds than in stocks in 2009 in today's free issue of DailyWealth.
 
Our own Doc Eifrig recently interviewed "the world's greatest market timer," Chris Weber. He asked Chris where he's personally putting his money and where the best and safest places for retiree cash are. You shouldn't miss it.
 
In addition to Chris' wisdom, Eifrig's latest issue of Retirement Millionaire shows you how to fly to Hong Kong in business class for cheap, which airline to avoid at all costs (it's a "piece of garbage"), and which airline is the best (and often the cheapest). And he shows you how to buy $25 of food from your favorite restaurant for $2.
 
Goldman Sachs conspiracy theorists take note... The Wall Street firm just hired away Barney Frank staffer Michael Paese to be its top lobbyist in D.C. The position was formerly held by Mark Patterson, the current chief of staff at the Treasury.
 
Now guess which investment bank has done the best under the Obama administration... It's the same bank whose executives sit in every conceivable branch of government... Since Obama took power, Goldman Sachs is up 90%.
 
Quietly, without any fanfare or any new marketing, we've been revamping our Inside Strategist newsletter. First, we hired an experienced, talented analyst – Braden Copeland. Braden, who graduated with an engineering degree from Duke University in 1994, spent the last 10 years putting together big real estate deals ($10 million to $70 million). I've personally been working with Braden since early March. In terms of the quality of his thinking and the thoroughness of his work, he is as talented as the best analysts here.
 
In addition to the new analyst, we've also simplified the content of the letter – which had featured tricky options trading and other complicated strategies. What we're doing now is easy to understand. We watch all the significant insider buying, every single day. We analyze the stocks carefully. Then, each week, we recommend the highest-quality stock where insiders are buying, if – and only if – you can still get shares at a very attractive price.
 
Over the past two months, we've recommended nine stocks – one each week. Our subscribers have been "filled" on seven of these picks, with the other two stocks not yet trading inside our "buy" range. So how have our picks done? Does combining very thorough securities analysis with insider buying produce good results? Absolutely.
 
All of our recommendations have gone up. That's no surprise since the market has done so well since early March. But our picks have done even better – much better. All of the picks we made during March, for example, have outperformed the market – all of them. The average gain from our March recommendations is now 44%.
 
Regards,
 
S&A Research




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