So I had to see for myself.
I’m glad I did. Some of the biggest criticisms against investing newsletters were put to the test. I figured, why not track some actual results and see how it does. Makes sense doesn’t it?
How do I know? First, all three of the primary, contrarian market indicators we follow in my Investment Advisory are showing strongly bullish conditions. Things that drive stock prices higher (i.e. credit, capital flows, and sentiment) are all near record highs. Credit has never been cheaper (record-low risk spreads). Cash into equity mutual funds has never been stronger (money flows). And sentiment has never been more bullish: 19 stocks with a market capitalization of $10 billion-plus are trading for more than 10 times sales. That's the most I've seen since the top of the market in 2000.
It's not only our proprietary indicators that have me worried. U.S. stocks have become very expensive – far more expensive than most people realize. The median price-to-earnings (P/E) ratio on the S&P 500 is now at a record-high level, eclipsing its peak from 2000.
Other historically reliable gauges of value – like the Shiller P/E – are also at record-high levels – above 25. Likewise, the total stock market capitalization compared with U.S. GDP is also at an all-time high. Now, you might quibble with these measures of value.
Shiller, for example, uses a 10-year-average earnings figure, a number that is unusually low because of the big accounting losses seen in 2009. I'd argue that in nearly every 10-year period, we'll see a similar stretch of earnings losses. Whatever issues there are with the index's make-up, it has been a statistically accurate indicator of future returns.
The same goes for the market-cap-to-GDP figure and the median P/E figure. All of these valuation measures and all of my proprietary indicators tell me the same thing: money put into stocks now, at these high levels, is unlikely to produce a positive return.
Are you cashing in on America's free energy source? Porter Stansberry of Stansberry & Associates is more bullish than ever on what he calls America's "free energy," natural gas. He's stocked the model portfolio of his newsletter, Stansberry's Investment Advisory, with natural gas companies as well as the companies packaging it and moving it. His energy position was by far the highest-producing segment of his model portfolio over the past two years, some of those holdings even having doubled. In this interview with The Energy Report, Stansberry discusses the macroeconomic climate facing North American investors and how to take advantage of a building natural gas trend.
The Energy Report: Let's start with something that was published in the S&A Digest Jan. 3. The headline was "Porter Stansberry: Why I now disagree with Steve Sjuggerud and Doc Eifrig," who are associates with Stansberry & Associates. Porter, in that article, you state that you're bearish on the market, citing that when the U.S. Federal Reserve stops quantitative easing (QE), interest rates will go up. Rising interest rates could be a catalyst for a stock market crash. Your colleagues feel that short-term interest rates will allow the market to continue to run. To what extent are you in disagreement?
Porter Stansberry: We are in disagreement because I think the timing is important. Steve in particular believes that the "Bernanke boom," which is the ongoing inflation of the credit market, will continue for much longer. He forecasts that, before this credit market bubble bursts, stocks will reach much higher valuations, 25 or 35 times earnings. That's a lot different than my outlook.
I believe stock multiples, the price that stocks are trading as a multiple of their annual earnings, are going to decrease substantially as the Fed begins to taper and interest rates rise. Stock price multiples are negatively correlated with real interest rates. As interest rates rise, the market multiple will fall. I see stocks getting less expensive. Steve sees stocks becoming much more expensive. I can't tell you who will be right.
TER: What's the catalyst for rising interest rates, as there wasn't a reaction to the initial tapering?
PS: I studied what happened in the bond and the stock markets during previous periods when the Fed stopped manipulating the bond market. In every single case, the moment the Fed announced that there would be a cessation of intervention, stocks declined and interest rates went up. The Fed is still buying $75 billion ($75B) worth of U.S. Treasury debt. It is the world's largest holder of Treasury debt, holding significantly more than the Chinese and the Japanese. The Fed is painting itself into a corner. If it does not continue to support the market, there is no doubt in my mind that prices for fixed income will go down. That means that yields will rise.
TER: What if the Fed very slowly tapers off the support?
PS: Let's just be clear about what happened: 10-year rates have gone from 1.6% last May to about 3% recently. Interest rates have almost doubled in less than a 12-month period. That is an enormous move. That changes the value of bonds significantly. It reduces the price almost by 50%. Folks who bought bonds that were yielding 1.6% have gotten killed. The Fed's buying is far more important to the market price of U.S. debt than any other economic variable. If the Fed stops buying, it doesn't matter whether unemployment goes up or down. It doesn't matter whether inflation is higher or lower. Its influence on the market is dominant. You can't expect the market to have the same price when the guy who's buying $1 trillion ($1T)/year of bonds steps away from the market.
TER: What's going to cause the Fed to step away from the market?
PS: Two things: There is overwhelming evidence that QE is not solving the country's economic problems. In particular, it is not increasing employment. There are 92 million (92M) Americans who aren't working. There are 50M people on food stamps. That hasn't improved from the Fed spending $3.5T on bonds. The rationale for this policy is nonexistent and the policy has been a failure. What the Fed is doing is economic suicide.
The Fed knows very well it's going to be incredibly painful to unwind. It has a ticking time bomb in its hands. The Chinese are running balanced budgets. They're running current count surpluses. They're buying up all the gold that comes up for sale around the world, and they're cutting bilateral currency agreements with every large economy in the world. All of this is laying the groundwork for making the yuan convertible in the capital account. What's going to happen to the dollar's role as the reserve currency around the world?
"Several of our analysts think gold is hitting a bottom, and gold stocks are one of the best values of the market today."
TER: Do you see a significant devaluation of the U.S. dollar in 2014?
PS: That's a realistic scenario for this year. Time is slipping away from the Fed. If the Chinese make that step, the Fed is going to have a lot less flexibility. It has to get its house in order; it has to stop this wild experiment with the monetary base for the simple reason that our currency is in constant competition with others. We are at risk of alienating our partners who hold our currency in huge numbers. Ask yourself a simple question: Do I think it's reasonable that the Fed will become the only global holder of Treasury bonds? That's the course we're on.
TER: If rates go up and markets go down in the U.S., to what extent does that also influence markets across the world?
PS: We're already seeing some impact—emerging markets have gotten crushed over the last 12 months. More money is on the margin. A 3% yield is more reasonable to a banker than a 1.6% yield. As a result, money is coming out of markets where higher yields are available like Brazil, and that is influencing bond and equity markets around the world. If I'm right and the U.S. yields go to something like 5% or 6%, there will be an absolute catastrophe in emerging market stocks.
TER: Would that mean lower stock prices in the U.S, and if the yuan becomes a stronger currency, higher stock prices in China?
PS: There will definitely be higher prices for Chinese equities. There are other key factors in the pricing of Chinese equities that need to be resolved, mostly the issue of the rule of law and the amount of transparency. China's equity markets have been badly damaged by the amount of accounting scandals the country has suffered during the past 18 months. I don't think there will be a quick or easy solution to that reputational problem.
TER: Then there really is no viable alternative currency to the U.S. dollar in the short term?
PS: The yuan is actually a very attractive currency and will prove to be very reliable—much more so than the U.S. dollar. I think the Chinese are going to come out with a gold-backed yuan, whether that is done legally or simply a de facto gold backing due to the size of their treasury's gold holdings. I think that they're going to offer a very high real yield, and I think that they'll do a good job, as they have done throughout the last 25 years in developing their economy. The problem, of course, is that the equity markets in China are not very well regulated and there has been a large amount of fraud.
TER: The newsletter writer Harry Dent believes the stock market will crash sometime between January and May. You expect a market correction. But where your views diverge is that Harry believes this crash will be followed by years of deflation. He points to the aging world population and a natural inclination for reduced consumption as you age. You believe there will be inflation as a result of the massive international QE. On the surface, that's a demographic trend versus a monetary trend. In your view, how do these two factors play out?
PS: Harry, as much as I respect his long career as a publisher and as a pundit, is just completely off base. Inflation is always and everywhere a monetary phenomenon. I don't care how much the population of Zimbabwe has aged or hasn't aged, when you're doubling and tripling your monetary base every year, you're going to have runaway inflation sooner or later.
TER: So what's an investor to do?
PS: The easy and simple thing is to own short-term, high-quality corporate bonds, so you could hold things that are going to mature in a year or two. If you're getting 6% or 8% on those bonds, you're going to be protected from inflation, and you'll have the ability to roll them over at a higher rate so that you don't have anything to worry about.
To protect yourself from loss of purchasing power, you can buy high-quality common stocks that are trading at a reasonable price, but with the ability to increase prices. In my newsletter, I just recommended the shares of Lorillard Inc. (LO:NYSE), which is a tobacco company that has the leading e-cigarette franchise. You can still buy that stock at about eight times cash earnings. It's incredibly capital efficient. It pays about 60% of every $1 of revenue out to its shareholders in the form of cash dividends and buybacks.
Obviously, precious metals have long been a store of value in a period of inflation. You can buy gold and silver. You can buy real estate. I've been buying real estate pretty much continuously since 2010. I started out by buying slum apartments in South Florida. I then moved into trophy properties as the volume in the market picked up and properties began to change hands. Most recently, I bought a farm. I borrowed some money at 4% and bought a producing farm that will pay for itself. Assuming that interest rates in the U.S. go above 4%, I'll get the money literally for free. Of course, I also expect farm prices to increase, so hopefully soybeans and corn give me a nice profit going forward.
I don't think there's going to be a crash, but I do think it's going to be very difficult for people who are heavily invested in very expensive stocks. Do you have any idea what the earnings per share multiple on Amazon.com is?
PS: One hundred and fixty six. Do you have any idea what Amazon.com's operating margin is? It's less than 1%, yet its shares are valued at 156 times earnings and more than 20 times book value. Investor expectations have become completely untethered to the reality of that business.
I'm not saying that Amazon is not a good business; it is. But at $180B and already dominating the U.S. retail industry, that company cannot grow fast enough nor can it possibly hope to increase its margins enough to justify investor expectations. The folks who are buying those companies are going to be very sorely disappointed.
TER: You have an interesting measurement that plays along with this concept called the S&A Blacklist. It includes companies with more than $10B in market cap trading at more than 10 times sales. You use this to determine if the market is getting frothy.
PS: Over the history of the equity markets, the number of companies that have been able to significantly increase and hold their value once they have been so highly overvalued is very small. Most companies that trade at these kinds of enormous valuations are never able to justify the valuations. Even if the earnings grow, the stock price declines.
Yes, some of these companies will turn into the next Facebook or eBay, but most of them will not. The ones that can't are going to crash. We keep track of this list because at market bottoms there are fewer than five companies anywhere in the world that are trading for more than $10B and more than 10 times sales, while at market tops, the number of companies that meet those criteria can be more than 12. Today, there are 20 companies on that list, which is the highest number we have seen since the 2000 market top.
TER: To what extent is that number really just a reflection of having nowhere else to put your money?
PS: It's a very big reflection of that. The Fed has driven people out of the bond market. People who were looking for reasonable, safe investments have been forced into things like master limited partnerships (MLPs) and real estate investment trusts. They have driven investors into riskier and riskier assets, and it's increased the number of people who are willing to invest in stocks at insane prices.
TER: Last time we interviewed you, you were very bullish on natural gas. In fact, you said, "I'm more bullish on natural gas today than I've ever been in my life." Is that still true?
PS: It absolutely is. I'm extremely bullish on the entire export energy complex in America: natural gas, propane, ethane, and everything that surrounds those industries like ships, pipelines and refineries. The entire complex is going to boom for a wonderfully logical reason that everyone can understand: In the U.S., natural gas and its other liquid components are free. Literally, this valuable energy source is being flared, is being burned into the air at lots of drill sites because we don't have enough pipelines to collect it all yet. That is even though natural gas is going for $17/thousand cubic feet in Japan and even though propane is going for $100/barrel in Germany. These are very valuable energy sources that have lots of demand globally. The only thing we have to do to make huge profits is build pipelines, refineries and ships. This is going to be a very long, wonderful market for America.
TER: How are you playing that opportunity?
"My energy position was by far the highest-producing position in my portfolio during the last two years."
PS: I bought some very low-cost equity where reserves are very large. I like Devon Energy Corp. (DVN:NYSE) and Chesapeake Energy Corp. (CHK:NYSE). I like companies like ONEOK Inc. (OKE:NYSE) that own the collection and distribution pipelines. I've bought the refiners and the distributors, like Targa Resources Corp. (TRGP:NYSE), that take the propane and package it on the ships. I've also bought boat companies, like Teekay LNG Partners L.P. (TGP:NYSE), a tanker company that can transport liquefied natural gas (LNG). These have been very lucrative for us. My energy position was by far the highest-producing position in my portfolio during the last two years. We made more than 100% on several of these recommendations, including Chicago Bridge & Iron Co. N.V. (CBI:NYSE), which is building out LNG port facilities around the world. It's a wonderful trend that still has a long way to go.
TER: The S&A Digest today said that "several of our analysts think gold is hitting a bottom, and gold stocks are one of the best values of the market today." Is it time to think about going into gold equities or do we wait for the correction?
PS: I am recommending certain kinds of gold equities in my newsletter at the present time. I like NOVAGOLD (NG:TSX; NG:NYSE.MKT) because it has an absolutely ironclad balance sheet. Whether the price of gold goes up or down this year, there is no way that it can or will go bankrupt. It has around $200M in cash on its balance sheet, and it has two gold projects that have very high-grade ore that are very likely to become mines. I view the shares of NovaGold, which are still below $3, as essentially a call option on the price of gold. This company will certainly be solvent for the next two or three years, and if the price of gold were to go up in that period, the share price would probably go to $10 or $20. It's a safe way to speculate on a higher gold price going forward.
But you have to understand that this is one position in a portfolio of probably 12 or 15 different recommendations. The allocation that I'm willing to commit to gold is still very small. That's the way I prefer to be an investor in gold. I like to hold gold bullion and find these very reasonably priced call options that give me time to wait for a higher price.
TER: Have you found other gold equities that have that special call-option profile?
PS: Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) are great ways for investors to have exposure to gold without having the risk of shaky capital structures. The key is to have plenty of runway to wait for a higher price. Having said all of this, I want to be very clear: Gold had a 12-year bull market. It is unlikely, in my mind, that that bull market will be followed by a short and painless bear market. I do expect higher gold prices in the future. I don't expect higher gold prices in the short term. I would be surprised if gold was more than $2,000/oz by the end of this year. I'm buying things that give me plenty of upside, but are extremely low risk and have no chance of bankruptcy. I still think you have to see a lot of bankruptcy in the sector. There are just too many shoddily financed junior mining companies.
TER: Is there anything else you'd like to share with our readers?
PS: My parting thought is that even if it is painful in the short term, it is incredibly important to the future of our country and to the future of our global economy that the Western governments get their monetary and fiscal houses in order. We cannot continue to run the world with fiat currency that comes spewing out of the printing presses at the rates we have seen over the last two years. The amount of malinvestment that will be caused by the dislocations of these prices and the bad economic decisions that entrepreneurs are going to make based on faulty assumptions about interest rates and market multiples will be very disruptive. The longer it goes on, the worse it will become. We have to get to a point where governments are able and willing to live within their means. We have to get to a point where people can once again count on currencies and market prices. Today, unfortunately, we're nowhere near that position. Until that gets fixed, people have to be very conservative with their personal finances.
TER: Do you think it will get fixed in your lifetime?
PS: It will have to, because we're on a collision course for a train wreck if we don't do something urgently to put our fiscal house in order and to get the government out of the business of manipulating the currency and manipulating interest rates.
TER: Porter, thanks a lot for your time.
PS: Sure thing.
Posted on Investing for Beginners 101
So I had to see for myself.
I’m glad I did. Some of the biggest criticisms against investing newsletters were put to the test. I figured, why not track some actual results and see how it does. Makes sense doesn’t it?
Instead of relying on these vague academic studies, I’d rather see the cold hard facts. For example, I’ve shared before about the downfalls of mutual funds, and how most mutual fund managers (over 80%) don’t even beat the market. But if you remember the conclusion, I recommended against mutual funds because of their expensive fees.
It all came down to the fees, because that is what had the biggest impact on individual investors. Performance varies depending on the manager, and I’m sure with some due diligence we could easily find a proficient mutual fund manager who beats the market.
But because mutual fund fees are so high, even with outperformance the investor is left worst off– most of the gains are absorbed by fees. That’s why I’m against investing in mutual funds.
How about investing newsletters?
It turns out that the studies on investing newsletters are very similar to mutual funds. Basically, the majority of investing newsletter writers don’t beat the market average, up to a percentage very similar to mutual fund managers.
In addition to that, many of the ones who do take significant drawdowns and risk. Meaning they have spectacular short term returns but then also lose more than the average during a downfall.
The only difference we are starting to see is that investing newsletters are much cheaper than mutual funds. If you are investing any little bit of significant money, the average cost per year of an investing newsletter will tend to be much less than a mutual fund charging 6% or more.
Again this brings me back to my original question: if investing newsletters aren’t helping investors make money then why are so many people buying them?
I decided to take a look at Porter Stansberry’s investing newsletter, the Porter Stansberry’s Investment Advisory. His company, Stansberry Research, claims to be the leader in investing newsletters.
Forget about the academic studies and let’s look at the facts. If you did an academic study of the average height in the world, you’d probably think that it’s highly unlikely that you will ever meet anyone over 7 foot. The numbers would tell you that anyways.
But if you happen to live in America, the chances of meeting someone over 7 foot are much greater (particularly around the cities that have NBA teams) than if you were somewhere else, such as China. A person in China could look at the same academic study and really believe that there aren’t 7 footers in the world, a person in a U.S. major city– not as much.
I tend to think that it’s very similar in investing research. I know for myself personally, I’m highly gifted in math. It comes very easily to me, to the point that I used to routinely win math competitions as a kid.
I’m not saying that to brag, but I believe a skill like that gives me a significant advantage over others in situations where math is important.
It leads me to believe that there can be others who are equally as gifted in the stock market. Therefore, the averages and academic studies wouldn’t apply to them. It’d be unfair to discredit them with this argument.
Which is why someone who claims to be the leader in investing newsletters is a great place to start. If they have the track record to back it up, then maybe others do too.
To see if this newsletter truly helps investors, I had to put very strict requirements on the whole process. This keeps the full integrity I want to establish at the forefront.
While good past performance is nice, it’s never enough to predict future returns. However, past performance is very useful to see how the writer responded to situations.
It will also help me determine if I approve of the investing strategy implemented, and if I can see how capital will be protected in case of unforeseen crashes.
Not only did Porter’s newsletter have to help investors, but I wanted to see if it would help the average investor as well. I assumed that the average investor makes $50,000 a year and invests 10% of it every month, which comes out to $416.66.
This $416.66 had to be invested into a recommendation from Porter, if there was no recommendation then the amount was saved for the next month. If there were 2 recommendations that month, $416.66 was split and invested evenly.
If there were 3 recommendations, the $416.66 was split 3 ways, etc. Whenever there was a sell recommendation, that amount would be added and invested in the next month. This allowed us to quickly compound our returns, which we will soon see was monumental in achieving success.
The key part of this exercise was that I included taxes and transaction costs. Some of the biggest criticisms against investing newsletters is that after taxes and transaction costs, the additional returns are canceled out and you would’ve been better buying an index fund.
I had to see if this was true. So for every transaction, I added a $4.95 transaction fee. You can get this low of a fee through TradeKing [ Get $50 when you open a TradeKing account today]. As for taxes, these were ignored for the following reason: If you trade in an IRA, your gains are tax deferred.
As such, our money can be compounded without being hindered by taxes. So right off the bat we’ve already debased one criticism of investing newsletters.
Now that taxes and fees are taken into effect, it’s time to see how Porter Stansberry’s Investment Advisor fared against the S&P 500 index fund.
But before I do that, there is one more restriction I had to add. I wanted to see how Porter’s picks did in both bear and bull markets. Instead of cherry picking a timeframe, I picked a constant one BEFORE I knew any of the results.
This protects the data from being manipulated by hindsight bias. I picked the time period January 2008 – December 2013. I thought of this period as the best because we get to see how the recommendations were during both a bear and bull market.
We get to see how Porter reacted to the great financial crisis of 2008, and how he was able to protect the portfolio while the general public saw 50% losses or more.
The results are in.
At the end of the time period, $29,583.33 was invested. Just buying and holding the S&P 500 every month resulted in $43,460.79. The investor following Porter Stansberry’s Investment Advisory would have $48,189.71. You can examine the details for yourself in this spreadsheet: Stansberry’s Advisory 2008-2013.
We can conclude several things from this data. First thing is that the S&P 500 index resulted in a CAGR (compounded annual growth rate) of 11%. Porter Stansberry’s Investment Advisory resulted in a CAGR of 12%. You might be thinking that this doesn’t seem like much. But consider how much the difference really can be.
The time period we examined was just about 6 years. Much too short to be a full investing career, but long enough to make some valid conclusions. For example, this 1% difference in CAGR. How would it affect the average investor?
Let’s take the above example again, but specify that our average investor is 25 years old. Remember that he makes an average income of $50,000 and invests 10%. What kind of results will he have by the time he is 65?
Well if he only invested in the S&P 500 index, and returns remained constant at 11% CAGR, he would have $3,229,083.75 by the time he retired.
The same average investor who followed Porter Stansberry’s Investment Advisory with 12% CAGR would have $4,295,644.00.
Now you can see the difference between just 1% in CAGR. It adds up to $1,066,590.25 over the lifetime of the investor, and this is with just an average income.
A person who makes more than $50,000 a year would see a much bigger difference than even the $1,066,590.
Keep in mind that this all assumes that the S&P 500 will continue to soar at all time highs like it does now. This is one of the best times ever to backtest an S&P 500 index strategy because the index has never been higher.
Consider if our average investor happened to retire at a time when the S&P 500 was in a bear market instead of the bull market we tested at. Suddenly, the gains would be 50% less or greater than we are seeing in this test.
This test is basically a best case scenario for the indexer. And it still loses by $1,066,590 to the investing newsletter!
On the contrary, Porter Stansberry’s Investment Advisor doesn’t rely heavily on the S&P 500 or need a bull market to return such gains. You see, because there are more transactions, most of the gains are realized.
Since the gains are already realized, they compound at a much faster rate because they can be immediately employed in a new recommendation. As long as the recommendations are good, as Porter’s were, the capital will grow extremely fast.
Another reason this strategy works so well is that the Stansberry newsletter implements a 25% trailing stop loss. At any time, a recommendation can only lose at most 25%.
Contrast this to the S&P 500 index strategy, which can experience a drawdown of 50% or more at any time. Although the fund is diversified, it is still at risk to lose more money.
This downside exposure proves that the S&P 500 index is even more at risk to market timing than is Stansberry’s Investment Advisory. Market timing is not a game you want to play, especially as you near retirement.
Despite the common criticisms against investing newsletters, this newsletter has defied all of them. Taxes were a non-issue due to using an IRA. Transaction costs were low enough to still earn the investing newsletter a 12% CAGR. Risk of capital was and still is less than an index due to the trailing stops.
Remember that all of these tests are based on an average income. For someone with a higher income, the transaction costs eat up even a lower percentage of the returns. This would further increase the CAGR of the investing newsletter.
With these cold hard facts in place, it’s hard to argue against Porter Stansberry’s newsletter. This skeptic is convinced.
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