Paul Learton's  Instablog

A man goes to see a psychic to ask about his future.

The psychic tells him that he will soon be $50 poorer. The psychic then charges the man $50 for the session. The man, being somewhat simple, is so impressed by the psychic’s abilities that he tells his friends.

The friends, also gullible, experience similar sessions with the psychic and are similarly impressed. They in turn tell their friends. Eventually the psychic is world renowned as the Ultimate Guru for forecasting the future.

Once his reputation is secure with millions of followers, he begins forecasting other items saying things like “tomorrow a lot of people will go the Golden gate bridge.” His followers all go to the bridge to see if it’s true. Sure enough it is: millions of people stand looking to see if others would show up.

The psychic has become a self-fulfilling prophet.

As laughable as this scenario seems, it’s roughly how today’s stock market rally is playing out. And the psychic is the “futures market.”

Unlike regular stock investments in which you purchase the investment the moment you hit “buy,” stock futures are investments in which you promise to buy at a specific price on a specific date in the future (hence the name “futures”). Think of it like going to the racetrack: you’re betting on what a particular outcome will be at some point in the future. Only you’re betting on GE trading at $15 a share on May 28, rather than “Big Brown” winning the Kentucky Derby at 10 to 1.

The futures markets trade around the clock (some of them 24 hours a day). Because of this, you can ALWAYS see exactly where investors are betting that the market will be trading at some future date. Say you’re getting bearish about stocks buy see that a bunch of folks just bet $2 million the S&P 500 will rally… well you might wonder if they know something you don’t.

Which is exactly what is going on in today’s market. For weeks now, any time stocks showed signs of breaking down (especially in the final minutes of trading), a large volume of bullish futures would be bought. The market would then surge higher as investors believed that someone knew something they didn’t. Thus, this market rally continues on weaker and weaker volume.

If you don’t believe me, have a look at this video from Fox News with Dan Shaffer, of Shaffer Asset Management:

http://www.foxnews.com...

Shaffer’s critical comments come around 2 minutes 30 seconds into the video. If you don’t have time to watch it or can’t get it to work, he says:

Something strange happened during the last 7 or 8 weeks… there was a power underneath the market that kept holding it up and trading the futures. I watch the futures every day and every tick, and a tremendous amount of volume came in at several points during the last few weeks, when the market was just about ready to break, and it shot right up again… it happened a week ago Friday, at 7 minutes to 4 o’clock, almost 100,000 S&P futures contracts were traded, and then in the last 5 minutes, up to 4 o’clock, another 100,000 contracts were traded, and lifted the Dow from being down 18 to up over 44 or 50 points in 7 minutes. That is 10 to 20 billion dollars to be able to move the market in such a way. Who has that kind of money to move this market?

I’ve mentioned before that I am skeptical of this market rally. Economic fundamentals are worsening. Trading volume is barely a trickle. And yet the market continues to jump every time is shows serious signs of breaking down.

Someone with a LOT of money has become the Self-Fulfilling Prophet of the stock market. I’ll detail who I think it is later this week. For now, just be aware that this market rally is being propped up by someone (or several people), NOT because corporate profits or economic conditions are improving.

Good Investing!

Paul Learton

 ps. author is short the S&P 500

Do you know about Master Limited Partnership (MLPs)?

MLPs are business entities, much like an LLC or Corporation. However, in the case of MLPs, ownership is divided between two groups: the general partner and limited partners. The general partner holds most of the voting rights for the business and oversees operations. The limited partners have little voting rights and are not responsible for overseeing the business.

However, BOTH groups get paid in a BIG way.

You see, MLPs pay little to no corporate taxes… provided they pay out most of their earnings to investors. Thus, it’s a win-win situation- the business dramatically reduces its capital costs, and the shareholders receive massive quarterly payouts.

And unlike corporate dividends which are taxed twice ⎯ once at the corporate level and again on your personal income taxes⎯ MLP distributions are only taxed once. Thus, the actual payout you receive is substantially larger.

Let me give you an example…

For every $100 in pretax profits a normal corporation makes, it typically pays about $35 in federal corporate tax and another $5 or so in state taxes.

Now, even if the company paid out the remaining $60 via a dividend to shareholders (it wouldn’t), the shareholders would still have to pay out an additional 45% in state and federal tax… leaving only $33 in income after taxes.

Thus, more than two thirds of that initial profit goes to the tax-man.

However, with MLPs, the entire $100 is paid out to investors… that is, the company pays no corporate taxes at all. So the payouts are only taxed once at the personal level. The end result is that with MLP pay-outs, $55 of that original $100 goes in your pocket: that’s nearly twice the payout you’d receive from a normal corporate dividend ($33).

Simply put, MLPs are the only corporate payouts in which you take home more money than the government.  As such, they offer some of the largest payouts available to ordinary investors today.

Just ask Dan Duncan.

With a net worth of $5.9 billion, Dan is the richest man in Houston Texas: the capital of oil billionaires. On average Dan makes more than $150 million PER YEAR. In 2007 alone, he pocketed nearly $360 million.

To put that number into perspective, it’s:

• Nearly four times as much as Merrill Lynch’s CEO
• More than 20 times as much as the CEO of Exxon Mobil
• More than 17 times as much as the CEO of General Electric

In fact, if you added up the payouts from all three CEOs, you wouldn’t even hit half of Dan’s paycheck.

However, Dan doesn’t make this money from some enormous salary or greedy stock options deal. In fact, Dan doesn’t even have a salary. Instead, he collects this enormous payouts strictly from distributions based on his ownership of the company.

So unlike the crooks on Wall Street, Dan’s interests are entirely 100% aligned with his shareholders. And he actually pays them twice as much as he makes himself. This isn’t a recent development either. Dan’s followed this arrangement every year since his company started making payouts:

Since 2001, Dan’s company has paid out a total of $4.7 billion, two thirds ($3.1 billion) of which went to shareholders. He’s also pocketed a cool $1.6 billion for himself.

To learn more about MLPs and Dan Duncan, you can access my FREE Special Report detailing these issues: The Billionaire's CD. Just go to gainspainscapital.com.

Good Investing,

Paul Learton

Joe America is tapped out.

After WWII, the US began shifting towards a consumer economy. However, this process was sped up rapidly in 1971 when we re-opened formal trade with China. As multinational corporations began shifting their manufacturing centers East to cut costs, American incomes and quality of life began deteriorating more rapidly: using the government's numbers, real (inflation-adjusted) average weekly earnings have fallen 15% from their 1972 levels.

You can see this in the stock market as well. As the US shifted to a services economy (especially financial services), the financial sector exploded. From 1970 until 2003, the financial industry expanded from less than 5% to 22% of the total market capitalization of the S&P 500. Over the same period, the sector increased its earnings from 10% to 31% of the total earnings of the S&P 500. Put another way, in 2003, virtually one in three dollars made by publicly traded corporations was made by a financial services company.

However, because Joe America had access to credit cards, he didn’t feel the pinch for some time. In fact, the combination of credit cards and cheap manufactured goods from China made Americans feel rich, though in reality they were simply spending their savings, filling their house with discretionary items.

This all came to a screeching halt once the Financial Crisis of 2008-2009 wiped out $50 trillion in household wealth. Since then, the US consumer has begun a seismic shift. For the first time in years the average American household is increasing its monthly savings. And this means one thing:

Retail is TOAST.

The below chart tells the whole story:

With unemployment already at a 25-year high and more Americans losing their jobs by the week, I expect this drop off in retail sails to accelerate throughout 2009. In particular, I expect clothing retailers to take it on the chin. After all, who’s going to go shopping for a new set of clothes when they’ve got no money coming in? And finding a job in this market is like looking for a needle in a haystack.

It’s already begun: clothing shops showed a 10% decline from the year before for the month of April. And it’s only going to get worse from here.

Which is why Gap (GPS) is ripe for a fall.

GPS owns the Old Navy, Banana Republic, and Gap store franchises. In this regard, the company has exposure to low price (Old Navy) medium priced (Gap) and relatively expensive (Banana Republic) retail demographics.

However, all three franchises appeal to roughly the same income brackets- the middle of the road folks who are cutting back more and more on their expenses. And despite the range in prices- everything from $20 jeans to $200 blazers- all of GPS’s clothing lines share a common quality: they’re not luxury goods.

Simply put, these are not high quality goods. They’re precisely the franchises that will suffer the most as consumers tighten their spending habits. In fact, they already are. GPS’s same store sales for 1Q09 plunged -8%, following up a 14% plunge in 4Q08 and a 12% drop in 3Q08.

GPS actually has a fairly long history of failure. The company hasn’t posted an increase in same store sales since 1Q04! GPS insiders are dumping their stakes as fast as they can. All told they’ve dropped more $30 million worth of GPS stock in the last six months alone.

Like the drop in same-store sales, this is nothing new: corporate insiders have sold off nearly 5% of the company’s shares outstanding in the last two years. This is an extremely bearish amount of selling. Clearly the company’s insiders don’t expect a rebound or rosy future for GPS.

Which is why it’s striking to see GPS shares trading only 28% off their 3-year high.

Let’s be blunt here. The US is currently in the worst recession going back at least 30 years, possibly bordering on a full-blown depression. Moreover, the world economy is entering its first contraction since 1945. And yet, GPS, a mid-line clothing retailer, is only 28% off its bull market high. Even more strangely, GPS, and retail in general have actually outperformed the market dramatically in the last three months… during a time in which the underlying fundamentals have completely fallen off a cliff.

This has the making of a major short sale: unfounded bullishness from investors with worsening fundamentals and insiders selling the farm.

When the next round of the financial crisis hits, GPS should retest is March ’09 lows. So cover your shorts if GPS falls below $10 a share.

Good Investing,

Paul Learton