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Weekend Edition

The Best of The S&A Digest
Saturday, August 18, 2007

Extreme Value editor Dan Ferris, quoting Felix Dennis, reminded me of something this morning: "Public companies aren't sane places, and their share prices aren't determined by sane people." That's why "quant" hedge funds, which are based on the idea that the markets are rational, i.e. efficient, seem to blow up once about every 10 years. And that's why, contrary to almost all academic research, contrarian investing works so well.
 
Real investors use market panics to take big positions in great businesses they understand. We've been waiting for the right time to buy – in some cases for decades. Case in point: Warren Buffett has been pouring capital into this market already. According to a Tuesday filing with the SEC (reflecting purchases through June 30), Buffett's Berkshire Hathaway has added significantly to its stakes in WellPoint and UnitedHealth (the two largest health insurers in the U.S.). Buffett also increased Berkshire's holdings of PSIA pick Johnson & Johnson (JNJ) by 9.2% and quadrupled its holdings of drug-maker Sanofi.
 
You might be surprised to know that neither the real estate panic nor the mortgage problems scare Buffett: He took his first position in Bank of America, buying 8.7 million shares, and increased Berkshire's position in Wells Fargo by 11%. He also bought more U.S. Bancorp, increasing his stake by 59% to 37.1 million shares.
 
Speaking of the insane... reading the local paper I found this:
 
"Nearly 4,000 homebuyers turned to the state [of Maryland] for their home loans last fiscal year, a record for Maryland's 28-year-old loan program... The state made about $767 million in low-interest loans to buyers." That's about three times more than the previous - 1995 - record of $250 million in loans. Why the huge jump in mortgage issuance by the State of Maryland? They're now offering 40-year, interest-only loans, loans equal to 99% of appraised value and 'down payment assistance,' which nine of our ten borrowers required to close. Stephen Silver, the CFO for Maryland's department of housing, says of last year's 4,000 borrowers: 'I'm sure we are picking up some people that were being steered toward subprime...'"
 
So... the State of Maryland... in all its infinite wisdom... has decided to use some of the 7.5% of my income it taxes each year to compete in the deadbeat mortgage market. Wonderful.
 
Gold's failure to rise amid the current market turmoil and decline in the dollar is leading many analysts to cut their price forecasts for the precious metal. Citigroup cut its 2007 forecast to $679 from $700. UBS, which predicted gold would return to its 1980 highs of $850, now predicts $670. Analysts are scared by the fact that central banks, holders of one-fifth of the world's gold, increased their sales of reserves this year by 7.3 percent.
 
Central banks have been selling for a long, long time, and gold's price has continued to rise. Imagine what will happen to the price when they stop selling... or when they try to buy it back.
 
What should you do in this market? Ideally, not much. If you're well diversified and holding mostly safe stocks bought at good prices, you'll probably see your portfolio fall 10%-15% in price through this correction. But the value of your holdings shouldn't actually change very much, and you shouldn't need to make too many, if any, changes.
 
We recently published a list in The Digest that featured our best, safe ideas. Keep an eye on these stocks. If the market experiences the kind of day I think might still be coming – a day of real panicked selling – then step up and buy a few more shares in several great businesses. I'd plan on buying into this market over the course of 12-18 months. Don't worry about trying to catch the bottom... just keep on picking up top-quality companies at good prices.
 
The U.S. stock market is "pretty solid" and offers some "great opportunities," says value investor David Dreman. In particular, the manager of $22 billion Dreman Value Management is interested in financials. The S&P 500 Financials Index has lost 10% this year and last week traded for 10.8 times earnings – the lowest valuation since 1995. Dreman mentioned that he's looking at buying shares of Extreme Value pick JPMorgan (JPM), 12% Letter pick Citigroup (C), and Wachovia (WB).
 
Regards,
 
Porter Stansberry




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