Worse than newsletter writers... Time to buy insurers?... 'Fudge' funds... Borders 'in play' with activists... Only $123,390 per share... Is China to blame for an emerging-markets bubble?

Which is more believable? The delusional ruminations of your newsletter editors or the timetable promised by the average contractor?

This summer, we decided to add a bluestone patio to our backyard. It was... we thought... a simple project. We wanted an outdoor fireplace at one end and a built-in gas grill at the other, with a small copper roof over the cooking area and a two-foot retaining wall around the whole thing.

We interviewed seven contractors. They all said, "This is easy... You'll be surprised how quickly we're finished once we get started." My wife picked the contractor with the most experience in our area. He was, of course, the most expensive too...

When he started construction in late July, he said it shouldn't take more than four to six to weeks. That was before his crew ran over our well and had to dig a new water main. Even so... this morning, at around 7:00, I woke to the sound of a front loader in reverse. Beep. Beep. Beep. Followed by the sound of a masonry saw. You can imagine how much our newborn likes the masonry saw.

Now in the 10th week of construction, our contractor says he'll be finished "in about two more weeks."

Here's an interesting way to play the subprime crisis... buy the property insurers. These companies are trading at their cheapest multiples since 2000 based on fears that they hold large chunks of subprime debt. In reality, subprime only constitutes 1% of their fixed-income assets.

The S&P 500 Property & Casualty Insurance Index dropped 6.2% in the third quarter, worse than the 4.9% drop of the S&P 500 Financials, which includes subprime-mortgage originators Lehman Brothers and Bear Stearns. The average property and casualty insurance stock trades at around 8.3 times earnings now, down from 17 a year earlier.

Shares of Allstate, the largest publicly traded U.S. home and auto insurer, dropped farther during the subprime scare (18% from peak to trough) than they did after Hurricane Katrina, when the company lost $3.6 billion.

According to an academic study by finance professors at Vanderbilt and Indiana University, hedge-fund managers will mark up the values of their hard-to-price assets and "round up returns" to keep numbers in the black. I'm shocked. Perfectly shocked... What's the old saying about such private partnerships? To start, the general partner has the experience and the limited partners have the money. But... by the end of the deal... it's the general partner that has all the money and the limited partners end up with experience.

Bill Ackman's hedge fund, Pershing Square, increased its holding in Extreme Value pick Borders Group (BGP) to 11.7%. Ackman also filed the increase as a 13D – meaning he intends to shake things up at the company. Another large shareholder of Borders, Spencer Capital, recently asked the company to add a person designated by Spencer to its board. Spencer owns 7.9% of the company. Shares jumped close to 7% on the news.

New highs: Alnylam (ALNY), Google (GOOG), Gen-Probe (GPRO), Janus (JNS), McDonald's (MCD), Sangamo (SGMO), SK Telecom (SKM), Berkshire Hathaway (BRK-A).

Berkshire closed at $123,390 – the highest stock price in the history of the markets.

In the mailbag – Are we alive? Yes indeed. And we read all of your notes. However, we don't respond directly to the comments or questions you send to our feedback e-mail. If you need customer service, please contact: customerservice@stansberryresearch.com. We have more than a dozen people working to assist you – but we're only one poor, tired writer. We couldn't possibly respond to everyone, individually.

But we do answer some questions and post some suggestions below. (Truth be told... we usually find the harshest criticisms to be the most interesting. We find ourselves publishing almost all of those.) Send your feedback here: feedback@stansberryresearch.com.

"I'm a new subscriber to your newsletter. In a 'prior life' I was CEO of a Midwest-based property & casualty insurance company. So, I read your analysis of [your October PSIA recommendation, an insurance company] with a keen eye and came away very impressed..." – Paid-up subscriber John Bubolz

"Question for you, my wife and I just came back from a trip to Disney World. While we were shopping in some of the Disney shops in downtown Disney I noticed a lot of the visitors were from England. I approached one man who had his arms full of merchandise and asked him what he thought of these high prices, he looked at me with astonishment and said 'High Prices are you crazy! These are the cheapest prices I have ever seen on these toys! I am stocking up for Christmas!' I was amazed, I commented, to me these prices seem outrageous i.e. the cheapest kids t-shirt was $22.00. He laughed and said his exchange rate was much better than he ever expected, basically two to one! Another Brit walked over and heard our conversation and said he was also buying tons of toys here, but his best friend back home is a taxi cab driver and he is in some serious financial trouble. He continued to explain since the US Dollar has fallen so much compared to the Pound that tourism back home is down double digits, and the drop is primarily from the U.S. since it costs Americans so much more to travel a lot less are visiting, which ultimately means less people needing taxis. Sorry for the long story but here is my main question, I was telling my wife how terrible it is for this country to have our dollar drop in value so much but her comments surprised me, she said isn't that good for our country? I almost fell over but she continued to explain if it is so much less expensive for foreigners to come here and buy our goods, more and more people will spend their money here in our country, plus exporting should be up huge for the American manufacturers, isn't that good for our country? Can you please explain to both my wife and me truly the pluses and minuses of our Dollar falling in value." – Paid-up subscriber John Bushie

Porter comment: If inflation and devaluation created wealth, then Mugabe's Zimbabwe would be the wealthiest country in the world, wouldn't it? And wouldn't all of those Latin American countries – who go through currencies like my wife goes through shoes – be richer than Switzerland? Your wife, witnessing an increase in economic activity, makes the mistake of only believing in what she can see and ignores all of the factors she can't.

Yes, by devaluing the dollar through inflation, our exports do become more affordable to foreign buyers. But, by the exact same amount, we lose the value of our savings and the ability to purchase all of the things we can't produce – notably oil. What's worth more? All of our savings and all of our assets or our export economy? As we lose purchasing power, our real estate, our corporations, and our bonds become devalued too – for foreign buyers. Before the late 1980s, the United States was a net creditor to the world. Now foreigners own more than half of the federal debt, more than one in three corporate bonds, and something around 15% of our entire stock market. Does your wife want to be an owner... or a renter?

"This is the fourth time I am trying to send an E Mail to You at Stansberry.
I have never seen any Response back in The S&A Digest to my legitimate Questions and suggestions. Could You please respond to show that You are alive." – Paid-up subscriber Harry J.

Porter comment: We are very much alive, Harry. We can't answer questions about your personal finances. And we don't respond to subscriber e-mails individually – it's simply not practical or a wise use of our time.

"Yes - pretty much all stocks are doing just fine at the moment. A monkey throwing a dart at a stock market listing sheet would be consistently picking winners too. So, let's wait for a few weeks into the next (inevitable) market downturn. When you guys can grow my portfolio in a severe bear market – that's when I take off my hat to your expertise and competence! That condition hasn't happened during all of my time as an Alliance member but could be just around the corner... stay tuned!" –Paid-up subscriber Peter

Porter comment: We'll do our best.

Regards,

Porter Stansberry
Baltimore, Maryland
October 9,2007

Investors are now paying to take on extra risk.

Let me explain... Historically, emerging-market stocks have been much cheaper than developed-market stocks.

The reason for the discount is simple: Emerging-market stocks are risky.

Why would investors take on extra currency and political risks if a similar stock in a safe, developed country has comparable earnings, book value, and yield?

Normally, they wouldn't... However, right now – for the first time in at least a decade – the price-to-book ratio of the DataStream Emerging Market Index is higher than the price-to-book ratio of the Developed Market Index.

Is China to Blame?

My first thought, after looking at these indexes, was that China must be skewing the results.

China is quickly maturing into a developed market... and that economic explosion has attracted a lot of speculative money. Consequently, China is very expensive right now...

To test my theory, I created an index that contained every emerging market except China.

Emerging Markets Now Trade at a Premium to Developed Markets

As you can see, removing China did not materially change the valuation... Any way you slice it, emerging markets are expensive right now.

Besides China, the most expensive emerging markets right now (according to book value) are some of the largest: Peru, Indonesia, and India.

So, I recommend waiting for a correction before buying up your favorite emerging-market stock.

Until next time...

Good investing,

Ian Davis

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