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Weekend Edition

The Best of The S&A Digest
Saturday, November 22, 2008

Our friend Whitney Tilson passed along this keen observation: The S&P 500's dividend yield rose above the yield on 10-year U.S. Treasuries for the first time since 1958 last week. At one point, the S&P yielded 3.55%, compared to 3.52% for 10-year T-bills.
 
 
What does this mean? Investors would prefer to own U.S. government obligations paying a fixed coupon instead of the largest U.S. companies. Prior to the end of the gold standard, investors might routinely decide they'd rather own bonds than stocks, as stocks are riskier. But bonds haven't offered higher yields than stocks since the U.S. went off the gold standard.
 
So why would investors choose to own low-yielding bonds in the face of the Fed's massive monetary creation over the last two months? They are now convinced a recession on par with the Great Depression is coming. Will they be right? Will U.S. government securities prove to be safer and higher yielding (in real terms) than stocks over the next 10 years? No way.
 
On the other hand, yields on speculative-grade corporate bonds are currently above 20%, the highest level in history. Before this year, the record high was 18.3% in October 1990, when 10-year Treasuries were yielding five percentage points higher than today. This is a once-in-a-lifetime opportunity to collect enormous yields on corporate bonds because of overblown market fears. And you're guaranteed to collect your money – all the company has to do is stay in business.
 
Mike Williams launched his True Income service last year to take advantage of opportunities like this. We're currently offering True Income at a large discount.
 
Companies including American Electric Power (AEP), Textron, Home Depot, Honda, Dow Chemical, and Nissan are pushing the Fed to buy their paper, i.e. bail them out. The coalition wants the Fed to go beyond top-rated paper and buy debt with the second-highest grade. AEP CEO Holly Koeppel said the group is looking to add more members.
 
Every time the government bails out another business, the stock market craters. And then more and more companies line up to be bailed out. Where will it end? Nothing scares me worse than this trend. It's what caused the Great Depression. And we seem hell-bent on repeating all of those mistakes.
 
The Big Three auto companies haven't been truly profitable in more than 20 years. Wilbur Ross says we shouldn't allow the Big Three automakers to go into bankruptcy because they'll be liquidated – they won't survive.
 
Exactly! They shouldn't survive. They haven't been competitive in two decades, or more. They have failed. If we give them more money, they'll still fail. It will only take longer and cost more money.
 
Bankruptcy wouldn't lead to mass unemployment. Other entrepreneurs would buy these assets and use them more wisely, putting people back to work and making better cars. Meanwhile, if you don't allow GM to fail, you'll end up crowding out the better companies, who have made better products and brought them to the public at a better price. If you never weed the garden, how can your flowers survive?
 
Of today's market, Marty Whitman of Third Avenue explains: "The opportunity of a lifetime seems to be present for passive investors who follow a few simple caveats." Those three caveats – which form the long-time basis of his "safe and cheap" mantra – are: 1) Be a buy-and-hold investor, 2) Don't use borrowed money to invest, and 3) Don't buy the stocks of businesses that need continual access to the capital markets for survival.
 
From a reader: Your columns constantly sing the praises of 'world-beating businesses' and 'cash-gushing franchises.' But when I look at their charts, I don't see why they're so attractive.
 
The charts tell you exactly what has happened to the price of the securities in the past. They tell you nothing at all about the value of those securities and nothing at all about what the price will be in the future.
 
Microsoft, for example, made more than $21 billion in cash over the last 12 months, up 50% from only two years ago. It has another $20 billion in cash on its balance sheet and no debt. It earns 23% a year on its assets and over 50% a year on its equity. Its products have gross margins above 80% (higher than Google's). And its stock has never been cheaper, as measured by its earnings yield (10.5%) – nearly three times more than U.S. Treasuries.
 
Over the last three years, Microsoft has repurchased $46 billion in stock. Assuming these buybacks continue (and Microsoft says publicly they will), there won't be any outstanding shares left in about 10 years. Put that on your chart.
 
Regards,
 
S&A Research
 
Porter Stansberry writes and edits the daily S&A Digest, which comes free with a subscription to one of our premium products.




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