We borrow at a low rate, and lend at a higher one, and collect the difference. That's it. But we do it much smarter than anyone else...

• We have no storefront, no employees, and therefore no real expenses.
• We only lend money where we have no risk of default (where the government has promised to pay if the borrower doesn't).
• And we only lend where there's real collateral.

Is it possible to make an investment that does this for us and let's us collect such an unbelievable amount of income - 15% — over the next year? Yes...

By the way, we've got a reader in San Diego to thank for this month's recommendation. After I spoke at a seminar there in March, he approached me and said:

"Steve, I'm a subscriber to your newsletter, but I'm 80 years old. Your newsletter says at my age I should have 20% in stocks. But what the heck am I supposed to do with all the rest of my money? I've got some of it in stocks, and a lot of it earning me next-to-no interest. You've got to give me a way to earn more with the rest of it..."

"Steve, I challenge you to find me a double-digit yielder that I can both understand and feel comfortable putting some of my non-stock market money into for your next issue."

This reader is exactly right! He's got some money in "safe" money and some money in stocks - but what's in between? What's he supposed to do with the rest?

A good challenge. And I'm sure that you're looking for the same thing he's looking for - a way to earn double-digit returns safely, outside of the stock market. So it's the main challenge I will answer in this letter. I promise, I've got a great solution...

LIKE A BANK, ONLY FABULOUSLY BETTER...

We're going to make 15.3% over the next 12 months in income, and have the government take on all the credit risk. All the investment I'm recommending does is act like a bank, borrowing at a low rate and lending at a higher one. Only it's got no branch offices, and no credit risk.

To show you how this is possible, let's pretend this is our business (since in fact, as shareholders, it is our business). Let's start as if we were building this business from scratch...

First, we come up with the idea that there's an opportunity to borrow low and lend high, just like banks do, only without all the costs of employees, rent, brochures, advertising, etc.

We need a good deal of money to make it really work right and maximize our economies of scale. A billion dollars should do it. So we set off to raise a billion dollars from potential big-shot investors...

"You see Mr. Big Shot, it's like a bank, only much better... We can borrow at 2.5%, and lend with NO RISK at 5%."

The big shots immediately scoff at the "no risk" part of course. And they also don't see how 5% minus 2.5% equals 15.3% in income. "Now hold on a minute, Mr. Big Shot..."

Here's how we get our 5%, and get the government to take the risk... We only invest in income-paying investments that the government has committed to back up. In other words, if the borrower turns out to be a bum, we still get paid.

Our "free money" (high income without credit risk) is really tied to what's called "moral hazard." For example, through the FDIC, the government will back up our bank deposits up to $100,000. Therefore, instead of you and me caring about the creditworthiness of a bank or any other hazards, since the government is "protecting" us, all we care about is which bank is paying the most interest. Before the FDIC, we actually had to be careful about which banks we put our money in.

It amazes me that our government traipses around the world shaking its finger at other governments for creating "moral hazard" problems like this, when the reality is, we may have the worst moral hazard problem of all - in our housing market.

The government's intentions are good. You see, our government desperately wants Americans to be homeowners. The websites of government and government-sponsored agencies talk about giving low- and middle-income Americans the "pride of ownership" who otherwise couldn't have it. And we all know that if you own something, you tend to take better care of it than if it's owned by somebody else (the government for example).

So the government, through government agencies and government sponsored agencies, does everything it can to encourage Americans to buy homes, including helping them buy homes (through FHA loans for example), granting tax breaks, and by guaranteeing the mortgages. This last part is the part we're interested in...

Here's the way it works. Joe Average goes into his local bank for a loan. The bank will actually make every effort possible to give him the loan, because it's going to hand off the risk of the loan to the government. The bank will give Joe Average a loan and then turn around and immediately resell that loan to a government agency or a government-sponsored agency.

What a great business - you take all the upfront fees from the loan customer, then you immediately turn around and hand all the risk over to a government-sponsored agency. And when the government buys the loan from the bank, guess what? The bank immediately has more money to lend to the very next loan customer walking in the door.

If you've wondered why so many banks have been popping up in your town and why you've gotten so many solicitations for mortgages, now you know. And it's getting out of hand... One in every three mortgages in the U.S. is bought by either Fannie Mae (FNMA) or Freddie Mac (FHLMC), the two large government-sponsored agencies. These two agencies literally have over a trillion dollars of outstanding mortgages combined on their books.

Here's where it starts to get interesting. What these government-sponsored agencies do with the loans they buy is they immediately turn around and sell groups of them to large investors. In order to entice investors to buy them, the government-sponsored agencies guarantee all of these mortgages. The deal is so sweet that as an investor, you would never even know if a borrower turned out to be a bum. That's the government-sponsored agency's problem. They'd take the loss, not the investor.

We want to be the investor here. We get all the interest from the mortgages, and these government agencies are stiffed with all the risk.

Here's what we do - we buy groups of these mortgages. Of course, we only buying ones guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae (the arm of the government that guarantees FHA loans that no for-profit lender was willing to make).

We buy those loans all at the same time, and we start collecting the 5% interest (of course, these are mortgages, so we will likely collect more than 5%). Remember, if someone defaults, we don't even know - the guarantors picks up the tab.

In order for this to be a real profitable business for us, we need to find a way to get our borrowing costs as low as possible. So we talk to the major financial institutions about our idea, and we get 20 financial institutions to commit to lending to us. Of course, we pledge our guaranteed mortgages as collateral, so these institutions, knowing those loans are guaranteed, are more than willing to lend to us at very attractive rates with those loans as collateral. They're willing to lend so cheaply in fact, that our cost of borrowing in the fourth quarter of 2001 was 2.6%.

The financials of our little billion-dollar business here couldn't be simpler. We take the $1 billion we raised from investors, and we borrow another $9 billion from those financial institutions, so we've got $10 billion to "play" with. (Incidentally, that's our simple balance sheet: $10 billion in assets (guaranteed mortgages), $9 billion in collateralized borrowed money, and $1 billion in equity. That's it!)

Let's say we earn 5% interest on those $10 billion in mortgages in 2002. That's $500 million in interest income. That's the top line, and that's easy to understand. And we really only have one cost: that's the "cost" of borrowing from those financial institutions. If our cost of borrowing in 2002 is 2.5% of $10 billion, then that's $250 million in costs. That's it!

Here's our sample Year-end 2002 Income Statement:

$500mn Revenues
$250mn Expenses
$250mn Bottom Line

The entire bottom line will be paid out to you and me in the form of dividend income. So that's $250 million in income, and the company is current valued at $1.3 billion. So that's income to you and me of 19.2%. Wow! That's astounding. The current environment for our little company couldn't be more perfect.

Let's say though, that the perfect environment doesn't hang around. And that revenues aren't quite that high (mortgage rates come down), and that expenses are higher (their cost of money goes up). Even if the bottom line is $200mn, that's still $200mn in income on $1.3 billion of stock market value - a 15.3% return for us as investors.

What can go wrong here? This sounds too good to be true...

You're right, it looks pretty darn good. And there are risks. The risks by themselves are very small, but the key is, they're amplified by our leverage — you've got to keep in mind, this company is controlling $9 in debt for every dollar in equity (kind of like putting 10% down on a house).

Leverage is the double-edged sword here. We're borrowing at a low rate, and investing at a high rate, with no credit risk, so the only way to bring home big returns is through leverage. And the reality is, these shares are much less risky than many banks in my opinion... For example, JP Morgan Chase, it appears, has exposure to Enron, Global Crossing, Argentina, and who knows what else? And on top of that, JP Morgan Chase has leverage of 20 times. We in contrast, have guaranteed investments and less leverage.

Why would you invest in a company with 20 times leverage with risky borrowers and high expenses when you can buy this stock, with about 10 times leverage, no credit risk, and no expenses? I don't know.

The risk of course, is if mortgage rates fall more than expected, or Alan Greenspan raises interest rates more than expected. For some reason, Wall Street analysts have the top line coming in lower (meaning that they expect interest rates to be lower in 2002 and the top line interest won't be 5%). Still this is no big deal. Based on Wall Street's calculations, that would give us a 14% yield. That's still excellent. When you have leverage, as this stock does, small moves in interest rates are amplified in our returns. But even if we "only" earn 14% in interest, we're looking good.

One final thing that gives me great comfort here... the former President of Grant's Interest Rate Observer, Jay Diamond, just joined the company as an Executive Vice President of credit research and analysis. Grant's, you may know, is the "crotchety old man" of Wall Street. The guys from Grant's have been skeptical about everything credit-related under the sun basically since time began. So to see the president of Grant's taking on a job in a credit analysis with any company is a strong sign about the credibility of the company. The fact that it's our company is as strong a vote of confidence about this investment as any piece of research or number crunching I could possible do.

The name of this investment is Annaly, and it trades on the NYSE under the symbol NLY. Buy as much of Annaly as you're comfortable with, not exceeding 10% of your investable assets (this is a higher percentage than I've allowed in the past). And collect your guaranteed income.

If credit trends do move substantially and unforeseeably against us, remember that this company is levered, and make sure you use your 25% trailing stop. In the absolute worst of all possible worlds, things could unravel. But the likelihood of that would be like The Perfect Storm. However, if we use our 25% trailing stop, we will be out in plenty of time, just as the storm clouds start to gather.

I don't expect that to happen. Or let me rephrase that - I think we can and will get many years of extraordinary double-digit returns out of this one before we might get knocked out of it. And with the likelihood of 15% returns over the next 12 months in income that's 100% guaranteed by government-sponsored agencies, I like my odds.

ACTION TO TAKE: Buy Annaly (NYSE symbol: NLY) with up to 10% of your investable assets, and collect a 15% yield over the next 12 months that's 100% guaranteed by government-sponsored agencies. Because of Annaly's leverage, use a 25% trailing stop on the share price to protect yourself from the unlikely "Perfect Storm."

"How many of you in the room tonight are stock market bulls, expecting the market to rise?" a speaker at the San Diego seminar asked. Only couple of hands went up. Instead of jumping to any conclusions, he went ahead and asked the obvious question:

"Well then, how many of you are stock market bears, expecting the market to fall?" Again, only a few hands went up. After an uncomfortable pause, somebody yelled from the back of the room:

"We're not bulls or bears - WE'RE ALL A BUNCH OF CHICKENS!"

Everybody laughed. But as I thought about it, it was a brutally honest answer. This was a room full of wealthy, mostly older investors (many in their 80s). These were experienced folks. And yet, they were scared.

If they were scared, then all individual investors must be scared of losing money right now.

While I can't say that I don't have fears, one fear that I DON'T have is that I'll lose money investing. I really don't worry about that. I don't worry about whether I'm doing the right thing or not either. I KNOW that I'll be okay...

I didn't start out this way of course. I started out every morning worried about what the market did yesterday, and what it was going to do today. I didn't have anything to guide me, so I was a "chicken" every day. And it cost me. I didn't act when I needed to. I didn't place the trade or the sell order; I didn't cut the loss or take the risk.

But a lot of hard work and a lot of time changed that. I've worked with countless investors and seen their mistakes. I've made my own mistakes. I've traveled the world looking for investments and seen most of what's out there. I've studied hard and completed my PhD in finance. And I've independently studied the markets and personally statistically tested a very large number of indicators over many years to find out what works. Because of this, I now have confidence. I've learned what matters.

I've boiled what matters down into a very simple, yet absolutely complete and very successful stock market indicator, the 1-2-3 Stock Market Model. It's easy to use too - and it doesn't change very often at all.

As you know, our stock market indicator has basically been in "sell" mode (RED LIGHT mode) since August of 1999. And it really couldn't have been much more accurate - with the exception of a one week whipsaw back in January it has been dead on.

What's extraordinary though isn't that the model saw past the stock market bubble, helping us to avoid the biggest losses in stock market history...what's extraordinary is that this market cycle was no different than any other time in the last 75 years for the model! When it's been in RED LIGHT mode stocks have lost nearly 10% a year...for the last 75 years. That's one heck of a track record.

I've just improved on the model slightly - more on that in a minute. And the new record of the model is truly dramatic: In GREEN LIGHT mode, which is strong buy mode, stocks rise at an astonishing 19.5% a year. In YELLOW LIGHT mode, which is buy and hold mode, stocks rise an average of 10.7% a year. And in RED LIGHT mode, which is sell mode, stocks fall at -9.7% a year. Over the last 75 years, stocks have spent about half the time in YELLOW LIGHT mode, a quarter of the time in GREEN LIGHT mode, and a quarter of the time in RED LIGHT mode.

And again, the model rarely changes. There are three inputs to the 1-2-3 Model (hence the name "1-2-3") - valuation, interest rates, and market action. Valuation has been bearish for a long time - stocks have been and still are expensive, as you can see from the chart. And with interest rates, with the exception of 1994 and 2000, the Fed has been cutting rates or leaving them alone for a very long time (rates have been falling essentially since the early 1980s), so that's been bullish. (This was the new change in the model - using the Fed Funds Rate starting in the 1990s instead of the Discount Rate)

However, market action (the third input of the 1-2-3 Model) does change, all the time. And today with the Fed on long term hold (bullish) and valuation still at sky high levels (bearish) my model has just flipped into YELLOW mode from RED mode based purely on market action.

Overall, the 1-2-3 Model had been unflinchingly bearish since August of 1999. Then we got our first whipsaw in January. After a very long stretch in bearish territory, our market action indicator (the 45-week moving average of the stock market) gave its first "whipsaw" early this year (as you can see on the third chart). A sign of a turning point to come? It looks like it.

Now here it's March. And we just got whipped up into YELLOW LIGHT mode again. The problem here, of course, is that we can't know which new signals from the market action indicator are whipsaws and which ones are the start of a new trend. So we basically have to accept each whipsaw as a new change. But one thing that is for sure, a few whipsaws always appear at market turning points.

So what do we do now that the model is flashing YELLOW LIGHT?

It's simple. Subtract your age from 100. That's the True Wealth recommendation for approximately how much of your investable assets you should have in stocks. Now this recommendation is only good during YELLOW LIGHT mode, which is most of the time. And that's where we are now. (Under RED LIGHT mode, the recommendation is HALF of your YELLOW LIGHT allocation to stocks.) Remember, under YELLOW LIGHT mode, stocks rise at 10.7% a year, so you don't want to miss out.

The most conservative approach to take is to start increasing your stock holdings. As we move farther into YELLOW LIGHT mode, you can continue to increase your stock holdings. If we get whipsawed out, back into RED LIGHT mode, heed the signal and back off. Follow your trailing stops.

In time, I believe the market will settle into YELLOW LIGHT, as I explain in the next section. These whipsaws almost always presage a major change in the mood of the market. YELLOW LIGHT mode is Buy and Hold mode, where stocks gain 10.7% a year. So don't be a chicken. Start upping your allocation to stocks now.

But where should you put the money? In safe, sound blue-chips? NO WAY...

On April 22, 1970, Ross Perot lost $450 million dollars in a day.

Without any explanation, shares of the company he founded, Electronic Data Systems (EDS), fell from $150 a share to below $100. By 1973, the shares had fallen to $15 - a peak-to-trough fall of over 90%.

The crazy part is, there was nothing wrong at EDS. To this day, shares of EDS have performed well - double the performance of the Nasdaq over the last two decades. The only thing wrong at EDS in 1970 was the share price had not dropped yet, while all the other technology and "story" stocks of the day had already been clobbered.

And after the "story" stocks were clobbered, everyone headed to "safety" in the big blue chips. And that's when investors really got clobbered...

What happened at the peak of the great bull market in the late 1960s is very similar to what happened at the peak in 2000, as people chased "story" stocks to nonsensical heights.

And chances are, most investors today are going to do exactly what investors did after the bull market peak back then: They're going to try to make a rational decision to invest "smarter" and "more conservatively." But as you'll see, the way investors went about that seemingly "rational" decision back then actually led most investors to lose half their money or more in 1973-1974 - and will likely lead investors today to lose half their money or more for the same reason...

However, if we heed the valuable lesson of what happened after the bull market peak of the late 1968, we will likely AVOID making the same mistake that millions of other investors will make, saving our own portfolios from ruin in the coming years...

The late 1960s was known as the "go-go" era in the stock market. (No, it doesn't have to do with free love and nude girls...although strip clubs were popular with investment bankers in the late 1990s as well.) It was called this because, like the late 1990s, it was a MOMENTUM market. Investors and fund managers would latch on to any investment idea and the investment herd would quickly bid it up to fantastic heights.

Whatever the investment idea was, it had to have a "story." Investors would buy the best story of the day and ride it. Until of course, an even better story came along. Just like the late 1990s, nobody really knew what these companies did. But their stories were exciting. And since they didn't have any history, the "possibilities were endless." Nobody wanted a "boring" stock - everyone wanted exciting growth possibilities.

By 1968 - like 2000 - we had many companies, selling on just a story, trading at 100 times earnings. A return to a more traditional level of 15 times earnings meant a FALL OF 85 PERCENT was in order. And, like 2000-2001, that's just what we saw. From 1969 to 1971, the "story" stocks were hammered. People wanted something real...

After fund managers and investors got clobbered by investing in story stocks, they were determined not to repeat past mistakes. So investors decided to put all their eggs in only the most sound, solid, big-name companies. They only bought blue-chip companies with real earnings and track records of success.

This is probably where we are today... Between the dot-com blowout and the Enron's and Tyco's, investors may be hiding from any risk.

After the peak in the late 1960s, the new logic in 1970-71 became: "So what if the price I pay is too high - these blue-chips are ‘One-Decision Stocks.' You just buy them and forget about them." And this may be where we are right now - out of the story stocks, and into the big names.

Back then, investors thought they were being smart. After all, who would question you for buying shares of Coca-Cola, or IBM? There were only about 50 of these true, big, blue chips. They became known as the "Nifty Fifty."

And just like today, where the Dow has held up significantly better than the Nasdaq (the Dow is still not far from 11,000, while the Nasdaq is still down 60%), the blue chips held up while the "story stocks" crashed.

The fact that the blue chips held up while the "story stocks" crumbled only added to the belief in the security of blue chips. Investor confidence came back in 1972. Nixon was re-elected, peace was at hand after a strange war on the other side of the planet, and inflation was under control. This is really starting to sound like 2002 and maybe 2003.

The problem with everybody buying the "safe" stocks was simple. Because investors had dumped everything BUT the Nifty Fifty, these big blue chips started to become very expensive.

The average Price-to-Earnings Ratio (or "P/E") for a stock throughout history has been about 15. Yet by 1972, big names like Disney, Hewlett-Packard, and McDonalds traded at P/Es of 76, 65 and 83 respectively. As a group, the "Nifty Fifty" traded at a P/E of 42 in 1972.

Then the crash came. By the end of 1974, both the Dow Industrials and the S&P 500 indexes were both nearly cut in half. Keep in mind that there was nothing particularly wrong with these companies... they were just overpriced. And those excesses were corrected in the 1973-1974 bear market, where stocks lost half their value.

I just ran the numbers on the 50 largest stocks in the S&P 500 today. These 50 stocks account for $6 trillion in market value - basically the equivalent of all goods and services bought by consumers in the U.S. in one year. Unbelievably, I found that the average P/E of today's top 50 is 44 - that's higher than the Nifty Fifty traded at their peak.

Now these are good names we're talking about here. The top ten include GE, Microsoft, Wal-Mart, and Intel. Nobody could fault you for owning these, right?

There may be nothing wrong with these companies...just like the Nifty Fifty of 1972. But also just like the Nifty Fifty of 1972, these stocks may see a 50% fall in the coming years. After all, a 50% fall in these shares would STILL leave these stocks expensive by any historical standard.

So beware: The big "safe" blue chips may just be the LEAST SAFE investments you can make right now...