Britannia Radio

The Daily Reckoning Thursday, February 4, 2010 TIPS on finding investments that "suck less" when inflation grabs hold, Panning for gold in the SEC's labyrinthine filing system, Plus, Bill Bonner with notes on the invisible depression and plenty more... Eric Fry, reporting from Laguna Beach, California... "You would probably suck less as a friend than you do as a boyfriend," a disgruntled girlfriend once remarked to your California editor. "But then I'm not really sure about that either." Your editor laughed, smiled at his girlfriend and replied, "Wow, that's the sweetest thing anyone has ever said to me!" This lighthearted conversation unfolded in the context of irreconcilable differences. (He was a sushi-eating Neil Young fan; she was a cheeseburger-obsessed Radiohead fan. There was simply no way to bridge this divide.) Despite their differences however, both parties sought an amicable resolution of some kind - i.e., the infamous "let's be friends" solution...that never seems to solve anything. Your editor and his disgruntled girlfriend were simply hoping to maintain some kind of relationship - preferably one that would "suck less" than the romantic one they were attempting. Many fixed-income investors have adopted a similar philosophy during the last few months. Since long-term corporate bonds have rallied mightily, while the yields on money market funds and short-term Treasurys have collapsed to slightly more than zero, attractive fixed-income opportunities have become very scarce. Simply stated, the bond market sucks. Therefore, fixed-income investors are lowering their expectations and hoping to find securities that "suck less." TIPS might fit the bill. Treasury Inflation-Protected Securities, also known as TIPS, offer "real yields" - i.e., yields after inflation. As such, these unique securities provide a return stream that protects fixed-income investors against inflation - the "kryptonite" of the fixed-income world. (Click here to discover all the scintillating details about TIPS). In yesterday's edition of The Daily Reckoning, we presented a thorough case for selling Treasury bonds. We have not changed our opinion during the last 24 hours. Runaway budget deficits, and the resulting risk of inflation, provide more than enough reason to avoid T-bonds, if not also reason to sell them short. (Selling T-bonds is, in fact, one half of Bill Bonner's, "Trade of the Decade.") The analytical team at The Daily Reckoning is well aware of the argument that Treasury bonds will rally and yields will fall as private sector credit contracts and the overall economy deflates. We are aware of this argument and we reject it. Deflation is an attractive theory; inflation is a fact. The astonishing magnitude and velocity of America's deficit-spending mania will ignite an inflationary trend that will incinerate the deflationary influences operating on the US economy. TIPS investors seem to agree. The inflation rate implied by TIPS prices shows an expectation of rising inflation. A little explanation may be in order here... The yield differential between TIPS and a conventional Treasury security of the same maturity is called the "breakeven inflation rate." This rate reflects investor expectations about future inflation. The higher the yield differential, the higher the implied future inflation rate. The chart below tracks the breakeven inflation rates during the last two years for the 5-, 10- and 30-year TIPS. You will note that inflation expectations collapsed during the depths of the credit crisis in late 2008. At one point, 10-year TIPS were pricing in almost zero inflation! But inflation expectations have been rebounding ever since. Today, 10-year TIPS anticipate an inflation rate of 2.39% during the next ten years - the highest anticipated inflation rate since July of 2008. Admittedly, 2.39% is a relatively tame rate of inflation. And that's just the point. If, as seems likely, the inflation rate accelerates over the next two years, TIPS investors will fare relatively well, while the holders of conventional long-dated Treasury bonds will be donning sackcloth and repenting of their faith in deflation. Net-net, TIPS suck less. You heard it here first. The Daily Reckoning PRESENTS: In today's guest essay, value investing maven, Chris Mayer, shows you how to better manage your own money...better than your mutual fund manager does, that is. Please enjoy and send any comments to the address below... Become an Activist... For Your Money By Chris Mayer Gaithersburg, Maryland Ninety-seven percent of all stock mutual funds are down from where they stood at the beginning of 2008. If you are surprised by this not-so- trivial piece of trivia, you shouldn't be. Very few mutual fund managers actually manage their funds in a way that could produce meaningful outperformance. So if it's outperformance you want, you'll probably have to do it yourself. According to Morningstar, the average stock fund rose 35% last year... But that wasn't nearly enough to overcome the 41% loss the year before. Only six funds achieved double-digit returns across the two-year span. And only two - two! - US equity funds have produced an annualized return greater than 10% during the last three years. I've long held that mutual funds are full of bad habits, like a boy who can't stop picking his nose or burping at the dinner table. If you had to design a poor investor, you would need look no further than the typical mutual fund. For example, the typical mutual fund turns over its entire portfolio at least once per year and owns 160 stocks. These are two things that often lead to mediocrity: too much trading and too many stocks. All that churning fattens the brokers of the funds. And the mutual funds often have unseemly arrangements to direct commissions to brokers who help market the funds. Owning all those stocks also means the fund managers often know little about what they own. No individual stock matters much, nor does any single issue make much of a difference, so why bother looking at any of them in detail? It is little wonder the typical mutual fund produces such an indifferent result. So I believe you're much better off buying a small basket of stocks that meet my four basic criteria: priced cheap, in good financial shape, with a business model that's easy to understand, run by managers who own a good chunk of shares themselves. One of the best ways to find stocks exactly like these is to comb through 13-D filings - which is a bit like panning for gold. The process is very time-consuming and the payoffs are rare. But investors who have the time and aptitude to conduct this sort of research can greatly improve their odds of success...and the magnitude of those successes. A 13-D filing occurs whenever an investor buys more than 5% of a public company. This filing, by itself, tells you nothing. You've got to do a lot more research to determine the whos and whys of each filing. But when you come across a filing by a known "activist" shareholder, you are usually onto something worthwhile. Yankees slugger Reggie Jackson once described himself as "the straw that stirs the drink." An activist shareholder is kind of like that. Having one of these guys in a stock you own is like having the home run-hitting Reggie Jackson in the middle of your lineup. The game can change in a hurry. An activist is someone who takes a big position in a stock with the intention of using that clout to change things. Possible changes might include pushing for a new board of directors or for selling part or all of the company. The idea is to actively unlock value in the shares, rather than sitting back passively and hoping for the best. You've surely seen the names of high-profile activists in the papers... Bill Ackman, Nelson Peltz, Carl Icahn and many others... Their activist exploits helped make them very wealthy. As investors, we can tag along in such efforts because anytime someone buys more than 5% of a company's stock, he has to file a 13-D with the Securities and Exchange Commission within 10 days of doing so. You can track 13-Ds by trolling around on the SEC's Web site or by subscribing to a service that tracks them for you. Barron's and some other publications also highlight 13-D filings on a weekly basis. These 13-Ds are great for investors like you and me. They are like little bells that go off alerting us that we should take a look at the stock. We won't buy all the 13-Ds we come across. But over the course of an investment life, we will find some fat pitches to put over the wall. One of the stocks I recommended recently to the subscribers of Mayer's Special Situations came to my attention by way of a 13-D filing by KSA Capital Management. In that 13-D, KSA disclosed that it owned 14.1% of the company. It bought shares between $33.39-39.18 per share from Oct. 1-Nov. 4. On Nov. 10, KSA's managing member, Daniel Khoshaba, sent management a letter in which he outlined his case that the stock was dramatically undervalued and that management should put the company up for sale. The stock is AEP Industries (AEPI). AEPI is currently trading for about $34 per share - very close to the lowest price KSA paid for its stake. But KSA paid as much as $39.18. Why? Because Khoshaba believes AEPI is worth about $110 per share. Obviously, if Khoshaba's estimate is in the ballpark, investors could make a sizeable gain buying the stock at the current quote. Regards, Chris Mayer for The Daily Reckoning Joel's Note: Right now you can employ Chris Mayer's premium investment research for a full month for just $1. He'll dig through SEC filings, attend investment conferences in your stead and traverse the world to bring you the best opportunities out there. You could do all that work yourself, of course...or you could grab the $1, one-month offer to Chris' high-end investment service right here. --------------------------------------------------------------- And now to Bill who has today's reckoning from Baltimore, Maryland... Dear, dear reader...we're sorry to write so much. We would have written less...but we just didn't have time. As expected...the Bubble Era was followed by the Bust Era. We're in it now. And as expected...the feds swung into action, busily making things worse. The last budget from the Obama Administration beats even our cynical expectations. We anticipated something stupid. But this is suicidal. Scandalous... More about that later... And we expected that the crash on Wall Street would be followed by a bounce on Wall Street. We even guessed that it would recover about half of what had been lost - which it did. What surprises us is that it went on for so long. Even now, we're still not sure it is over. Yesterday, the Dow went down 26 points - after a couple of days of 100+ gains. Gold fell $6, which wasn't bad considering how strong the dollar has been. The dollar has gone up - but not exactly as expected. We thought it would go up as investors fled stocks and commodities. Instead, the dollar rose long before stocks and commodities began to fall. Either the last phase of the bear market has begun. Or it won't be long before it does. Stocks can go any which way they want in the short run - depending on investors' delusions. But in the long run, reality catches up to them. And the reality is: we're in a depression. Stocks gotta get with the program. But since the depression is invisible to most economists, the burden of proof is clearly on us: "Retail sales continue to soften," says one headline. "Home ownership level falling to 67%," say another. "Personal bankruptcies up 15% from January '09," adds a third. Bear in mind that a year and a half has gone by since the slump began. If this were a normal recession, we'd be recovering by now. Instead, another report tells us that the unemployment rate has topped 15% in 19 different states. Now, that's beginning to sound like a depression, isn't it? Another report tells us that now half the states are insolvent. Why? Tax revenues have collapsed, while the politicians failed to cut spending. The latest GDP growth report came in at a surprisingly high reading over 5%. But take out the restocking of inventories...and the federal stimulus...and you have a negative number. Which means, the stimulus isn't stimulating. It's displacing. The private economy is giving way to the government economy. This week, for example, the federal payroll hit a new record - 2.15 million. What do all those people do? More on that some other time... Which brings us back to the federal budget deficit. At 11% of GDP, it's matched only by the deficits of the war years - the War Between the States, WWI and WWII. Each time, lenders were willing to go along with such high deficits because the future of the country was at stake (or so they believed)...and because they were confident that the deficits would disappear after the killing stopped. But this new deficit is a whole 'nuther animal. First, there is no real war going on. Second, there is no end to the deficits. The Obama administration itself candidly admits that the deficits stretch out as far as the eye can see. Now, a question: since this is not like the deficits of the war years...why would lenders act as though they were? Why would they accept the same rates of return? The deficits are shocking enough in themselves. But while the quantity (in GDP terms) may be equivalent to those of the war years, the quality is totally different. Which makes us think lenders are making a big mistake. They look at the deficits and say: 'we had deficits that big before...we survived.' But these deficits are different. They are serious deficits without a serious war... They just get bigger and bigger. And they don't go away. Investors are going to be sorry they bought US debt... And more thoughts... Here at The Daily Reckoning headquarters we're happy with a depression. It makes us feel at home. Baltimore has been depressed for the last 40 years. Ever since the riots of the '60s, the city's been going downhill. There are whole blocks that could be bulldozed to the ground...no one would object. No one would be displaced. The city probably peaked out in the '20s. That was when the suburbs began draining off its best people. Then, WWII brought in different people - poor, uneducated, uncivilized hicks from the mountains and field hands from the South. They worked Baltimore's factories and destroyed its neighborhoods. Then, the best of them moved out too. Now, there's not much left. Depression ain't so bad. You get used to it. You even get to like it. Restaurants empty. Parking lots deserted. Offices, movie theatres, houses - all abandoned. There's a sort of end-of-the-world, Zombieland quality to the city. Certain neighborhoods, we're convinced, are inhabited by zombies. During the daytime they are deserted. The Zombies must come out at night...who knows? Is the US headed towards a 40-year downturn like Baltimore? Probably not. Baltimore's decline came about because its industries were no longer profitable...and its middle class moved out. America's middle class isn't going to leave. Who would take it? On the other hand, her industries are clearly in trouble. When it comes to making things, other countries can make them better, faster and cheaper. The only exception we can think of is movies...and we're not sure about that. In the Bubble Era, fantasists such as Tom Friedman imagined that the US had a lock on innovation and invention. Even that seems to be slipping away. What's the biggest new thing in transportation? The electric bicycle! No kidding. They are catching on in Asia and in Europe. Soon, you'll see them in America too. Well, that is if drivers don't run over too many bicyclists before learning how to share the roads with them. Where were the electric bicycles developed? In China... Now, western firms are trying to copy the Chinese designs! "Whooppee! This is a lot nicer than in France. We never got a snow holiday in France. Never. Whoopee!" Edward is delighted with his new life in America. At least he was at 7AM when we reported to him that the Montgomery County schools were closed because of the snow. Your editor and family are rediscovering the United States of America. Last night, we went out to a nice restaurant. "If I order a hamburger...will you cook it medium rare for me?" we asked the waiter. "What? We don't serve hamburgers...." "Darling...this is a good restaurant," said Elizabeth. "They don't serve hamburgers. And please don't get in a fight with the waiter." "I wasn't getting in a fight. I just wanted to know if it was some sort of health department regulation..." "No, it's not. Remember, we went to Fuddruckers the other day. We got hamburgers medium rare, I think. They were very good." "Oh...well...this country has changed so much. It's so strange. I don't know what to think..." Regards, Bill Bonner, for The Daily Reckoning --------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com   The Daily Reckoning - Special Reports: The US Trade Deficit: Fort Sumter...And The U.S. Trade Deficit US Recession: By far the Weakest Recovery "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.