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Weekend Edition

Porter Stansberry: The madness of the crowd cannot sustain this rally
Saturday, November 23, 2013

 I see two critical phenomena taking place in the market right now... And I hope people will pay attention to them.
 No. 1, the retail investor has returned to the stock market in a huge way. If you look at mutual-fund inflows, they're very powerful. In October, U.S. equity funds had net inflows of $10.5 billion, the highest monthly inflow since January. These inflows are the biggest influx we've seen into stocks since 2007.
 Unfortunately, I believe the retail investor is late to the party. Too much money is going into stocks right now at too high of a price. This is not the time to be buying stocks. You want to be buying stocks when other people are selling them, not when everyone in the world is buying them.
I sincerely thought the market top was being made in early June and in May when the junk bonds peaked and yields fell to less than 5%. I've been early on that call. Nevertheless, I don't think it's going to end well for the retail investor.
 The second thing is this entire rush into stocks is being driven by the Federal Reserve. And the Fed's interest-rate policy and its quantitative easing are unsustainable...
You'll often hear that in the short term, the stock market is a "voting machine." That means that in the short term, the prices are set by the passions of the crowd. And the passions of the crowd are easily manipulated by public relations, political campaigns, and false beliefs. That is always what happens.
The idea, for example, that the federal government can borrow $17 trillion at a blended rate of about 2% is insane. That is more than 100% of U.S. gross domestic product in debt. And our government has unfunded liabilities with a net present value of $1 million per citizen. That shouldn't happen.
 Over time, however, I guarantee you the market is a "weighing machine." Eventually, the true value of an asset is revealed. Here again, when it comes to our country's debt, the idea that our government's policies are normal or sustainable will absolutely fail. The madness of the crowd cannot sustain the utter dominance over time of a weighing machine.
Sooner or later, capital is going to flee to where it is treated better. And our government cannot afford higher rates. If our government was forced to pay a true market rate of interest (which I believe would be 6%-8% annually), it would be more akin to a junk bond than the world's leading sovereign credit.
You can do the math for yourself on what interest payments would be if the government had to pay 8% on $17 trillion – $1.36 trillion annually. Meanwhile, the total amount the U.S. government collects in taxes is around $1 trillion. So there's no way we can possibly afford the debts we already have. That's a simple fact.
 The simple numbers make it clear... Our government's current debt-fueled policies are unsustainable and creating a huge crisis.
Sooner or later, that fact will overwhelm the smoke and mirrors and the chicanery of quantitative easing. Sooner or later, that fact will overwhelm the passions of the world's banks that keep 60% of their reserves in U.S. dollars. Sooner or later, that fact will overwhelm the popularity of the U.S. dollar as the basis of international trade.
 And make no mistake... China has had good reason to negotiate bilateral trade and currency agreements over the last 18 months with every single major trading counterparty in the world. At some point, the Chinese will unveil a complete convertibility of its currency, the yuan. And when that happens, what do you think will happen to the value of the U.S. dollar? What do you think will happen to the actual rate of interest on U.S. Treasury bonds, especially long-dated bonds?
 All of those things will change because, as I said, the markets over time are weighing machines. And I guarantee you the passions of the crowd change over time. So the current pricing for equities in the United States is based on 18 years of earnings.
Facebook is trading at a valuation of around 100 years of earnings. But what is the value of all those future earnings if the value of the dollar crashes? What is the value of all those future earnings, 15 years', 17 years' worth of earnings, if instead of the long bond being 3%, it was 8%?
If you do the math, if you look at the dividend discount models, and you compare it with the risk-free rate, you can see for yourself that valuations of U.S. stocks could easily fall in half.
When I look at the key indicators I use in my Investment Advisory, I see 18 stocks on our "Black List." That means right now, 18 companies with market caps of more than $10 billion are trading at more than 10 times sales. That is not going to end well. Maybe one or two of those stocks will thrive over time, but most of them will fail badly and will wipe investors out. That's just a very high-risk indicator to me.
 I believe that we are in the very late innings of the stock market rally. The Federal Reserve cannot continue to print $85 billion a month, and every central bank in the world cannot be in competition to see who can print more money.
This is totally unstable, and it will not last. What's scary is everyone in the whole world can agree that there's no risk. They believe quantitative easing is fine and everything will be OK. But then there will be that moment when for some reason – and no one will know why – the entire attitude changes.
And then, all of a sudden, the world will abandon government bonds. It's going to abandon government paper because it's no longer reliable... because governments have warped the prices to the point where it no longer works.
We can't know when that moment will come, but we do know either that has to happen or the Fed has to stop printing. And when either one of those two things occur, yields are going to go higher. Inflation is going to return, and it will be very difficult for the stock market to maintain its current price-to-earnings ratio of 19 as bond yields ratchet higher.
And I know that you'll be way better off as an investor if you can learn to be greedy only when other people are scared. And right now, people are clearly not afraid of stocks.
Porter Stansberry

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