The Weekend Edition is pulled from the daily Stansberry Digest.
Porter Stansberry called it "probably the most brilliant idea I've ever seen us produce"...
That's high praise from Stansberry Research's founder.
So you can imagine how motivated I was to prove him right.
Porter was talking about a stock-picking strategy that my colleague Bryan Beach and I developed last year. We now call it our "Golden Triangle" strategy.
Porter saw the results of our extensive back-testing of the strategy... They were almost too good to believe. Since then, we've put the strategy in practice across several of Stansberry Research's publications.
It's been almost exactly a year since we first shared this strategy with readers, and I want to share with you how it is performing so far.
But first, for new readers, let me briefly explain the strategy and how we discovered it...
As is the case with many discoveries, we stumbled on it by accident...
Bryan and I were working on the June 2017 issue of our corporate-bond newsletter, Stansberry's Credit Opportunities.
Every month, our team looks for what we call "outliers"... mispriced bonds that are trading at prices far too cheap given their level of risk. (Sometimes, bonds trade at discounts to their "par value," which is normally $1,000 per bond. Investors are legally entitled to collect the $1,000 par value at the bond's stated maturity date, plus interest payments along the way, regardless of how much you pay for the bond.)
That month, we were studying a corporate bond of a company we admired. The only problem was that its bond was too expensive, trading close to par value.
When we looked at the company's stock price, we were shocked... It was just the opposite. It was incredibly cheap. The share price had been cut in half over the previous four months. That made no sense at all.
The company that issued the bond produced huge cash flows... was in solid financial shape... and yet the stock was trading at a huge discount to its peers.
Bondholders clearly weren't worried about the future of the company... Meanwhile, equity investors had given up. Clearly, one set of investors was wrong. Either there was no reason to worry (as the bond investors thought), or the company was in deep trouble (as the stock investors thought).
This inconsistency intrigued us.
As we studied the company, we realized the bondholders were right...
You've probably heard the old saying that the bond market is smarter than the stock market. We saw evidence of it firsthand with this company.
Adages and anecdotes are fun, but Bryan and I are trained accountants. We live by numbers, data, and hard evidence. We wanted to know if anyone had ever proven this theory. After our searches came up empty, we conducted our own extensive study.
We studied hundreds of situations where the bond market and stock market disagreed. We found that the old adage was, in fact, true. Bond investors really are smarter than stock investors... most of the time. (I'll explain this caveat in a moment.)
But more important, we had stumbled on a strategy that could be used to identify stocks that were poised to double in a relatively short period of time. These were stocks that had sold off sharply and indiscriminately while the bond market yawned. What we found was the stock market eventually realizes its mistake. Within two years, on average, this group of stocks more than doubled.
Take a look at the following chart...
It shows the stock and bond prices of a representative index of the 100-plus companies we studied where the bond and stock markets disagreed...
The black line is the average stock price, and the blue line is the average bond price (indexed to a baseline beginning price of 100 for easier reading). The bottom axis represents the time from when these stocks first began to sell off.
We call this our "Golden Triangle" strategy because, in practice, you want to buy the stock when a triangle starts to form.
The first side of the triangle (the vertical gold line) represents the divergence between the stock and bond prices. The second side of the triangle (the horizontal straight gold line at the top) plots alongside the bond price, never straying far from par. And the third side of the triangle shows the steadily rising stock price.
You can think of it like this: On average, the stocks where the bond market disagreed were trading at $100 a share and dropped to around $40 a share, a 60% loss. Within two years, this "average" stock was trading for around $89 a share... just 11% below pre-crash levels. But it's more than a double from the low. After two years, these stocks produced an average gain of 123% from where they bottomed.
Of course, that's just the average. Some stocks performed much better than that. Nearly every stock where the bond market disagreed showed a gain two years later. More than 60% of the stocks doubled within two years. And we didn't even try to "cherry-pick" the best stocks from the group.
The beauty of this strategy is that you don't need the market to fall in love with these stocks for it to work. The stocks just need to trade back to the levels they recently traded to double.
Without even trying, we had discovered a way to use the corporate-bond market to reliably identify stocks that are poised to soar.
Porter saw the results. As he said...
You can put big capital into these ideas without feeling like you're crazy. And it has a very high "hit" rate – it works virtually every time.
Back-testing a strategy is one thing, but seeing actual, real-world results is completely different...
So today, roughly one year after unveiling our discovery, I'm going to show you how the Golden Triangle strategy is performing so far for the companies we've actually recommended.
Since first publishing the results of our study for Stansberry's Credit Opportunities subscribers last year, we've implemented this strategy in several Stansberry Research publications.
Our first official recommendation using the strategy was published in the July 2017 issue of Stansberry Venture Value. Bryan recommended movie-theater advertiser National CineMedia (NCMI). Then in December, Bryan recommended a second Golden Triangle setup – medical-device maker Hanger (HNGR). (He highlighted another interesting Golden Triangle setup in August, although he passed on recommending the stock due to some accounting irregularities.)
We also shared the strategy with subscribers of our flagship publication Stansberry's Investment Advisory in September 2017, recommending beaten-down iconic fashion brand Ralph Lauren (RL).
At the annual Stansberry Alliance conference in Las Vegas later that month, Bryan and Porter presented the strategy on stage. They showed how it could be used to find high-quality stocks in the most hated corners of the market. At the time, no sector was as hated as retail.
They shared a list of seven beaten-down retail stocks where the bond market clearly disagreed with the stock market. While they didn't make an official recommendation, Bryan and Porter mentioned six of those seven opportunities as potentially profitable setups, while passing on the seventh.
And in December, we began officially publishing Golden Triangle recommendations as a supplement to our bond research in Stansberry's Credit Opportunities. Since then, we've recommended eight Golden Triangle stocks.
Not counting the Vegas presentation, we've now shared a total of 12 Golden Triangle ideas, and recommended 11 of them.
So, how is the strategy performing so far?
Before we get to the results, remember that we have to give this strategy two years to fully play out. Our back-testing showed that the stock market doesn't always realize its mistakes right away for every opportunity. We haven't even held a single position for one full year yet. Our average "holding period" across all 11 recommendations is just 167 days, or around five months.
Still, the results so far have been stellar.
In the table below, you can see the results by publication. We've compared the returns to date with the returns you would have earned if you had invested in the benchmark S&P 500 Index instead (including dividends).
These 11 ideas have generated an average annualized return of 20.9%. If you had invested in the S&P 500 instead of each of these ideas, your total return would be less than one-third of that... just 6.6% annualized. (And that's factoring in two closed positions in Stansberry's Credit Opportunities that we stopped out of... something we didn't use in our back-testing.)
In other words, we're more than tripling the return of the overall stock market so far.
Amazingly, these stellar results don't include the six additional stocks we highlighted at the conference in Vegas, which have risen an incredible 32% since September (or 42% annualized).
I expect the results will be even better next year.
This strategy has even caught the attention of high-profile investors outside of our traditional readership...
For example, in April, Wall Street legend Jim Grant invited Bryan to present the strategy at the prestigious Grant's Interest Rate Observer conference in New York City.
Bryan shared the stage with financial icons like Oaktree Capital Management's Howard Marks and Saba Capital Management's Boaz Weinstein.
We've also heard that the quant fund for Steven Cohen's SAC Capital Advisors is back-testing its own version of this strategy after hearing Bryan talk about it at the Grant's conference.
But it would be a huge mistake to assume that the bond market is always right...
History proves that the bond market is right far more often than not... and far more often than the stock market. But when it's wrong, it creates massive opportunities for smart investors. We're on the hunt for these anomalies – severely mispriced bonds that trade at prices far too cheap given their level of safety. In fact, we created Stansberry's Credit Opportunities specifically to take advantage of these bond-market inefficiencies.
Depending on where we are in the credit cycle, it can be more difficult to find mispriced bonds. When everyone is piling into corporate bonds – as they have since the end of the last financial crisis – it's difficult. But in the midst of a credit crisis like we saw in 2008-2009, it's much easier to find these anomalies.
Today, investors are chasing yield and ignoring credit risk, which has driven up the prices of even risky bonds. What we see today is the exact opposite of what we're looking for... bonds that are far too expensive given their level of risk.
We've likened finding anomalies in this environment to spotting Bigfoot.
And yet, despite the challenges, we do occasionally find Bigfoot. I'm proud to report we've done remarkably well since launching Stansberry's Credit Opportunities in November 2015.
Since then, we've recommended 24 bonds. We've closed 15 positions with an 87% win rate. The average annualized return of our closed positions is 33%.
That's more than three times the return of the overall high-yield (or "junk") bond market in the same period, as measured by the return of the largest high-yield bond exchange-traded fund, the iShares iBoxx High Yield Corporate Bond Fund (HYG).
More impressive, it's almost double the return of the overall stock market, as measured by the S&P 500... with investments that are far less risky.
We've achieved these results despite the fact that we're in the late stages of a bull market in stocks... And before any panic in the credit market has set in.
In other words, the party hasn't even started yet. The biggest opportunities are still ahead of us.
During a credit crisis, when panic sets in, prices can fall hard... and fast...
In fact, many institutional investors are forced to sell their positions when bonds are downgraded from investment-grade. This is just one of the reasons we expect to see bond prices plummet during the next credit crisis.
Don't be fooled by the calm in the credit markets. As Porter has warned, a crisis is coming... and soon.
Corporate debt is at an all-time high, both nominally and as a percentage of gross domestic product (GDP). And yet, the corporate default rate is low, around 3%. This rate can't stay low forever. But two things are happening today that will cause this rate to rise...
- A tidal wave of debt – a record $4 trillion – is coming due over the next five years, and
- Interest rates are rising... fast.
Companies binged on debt over the past decade, taking advantage of artificially low rates. But the day of reckoning is upon us. These firms now have to refinance huge portions of that debt coming due over the next few years, starting this year. Many of them can barely afford the interest on their debt today.
Banks won't be willing to lend new money to some – like now-bankrupt retailer Toys "R" Us. Many of the others will default on their debt and collapse as rates go higher.
As the interest and default rates rise, credit-ratings agencies will start downgrading more debt... And bond investors will begin to panic.
Here's some proof of how quickly things can change in the bond market...
At the end of 2007, the default rate bottomed around 1%. It quadrupled to more than 4% in 2008 before soaring to 12% to close 2009.
Here's another more recent example...
Take the March 2018 bond issued by Iconix Brand Group (ICON). Iconix owns around 30 brands like Joe Boxer, London Fog, Mossimo, Ocean Pacific, Danskin, and Umbro. It doesn't manufacture anything. It just licenses the brand names and collects royalties on every sale.
Last November, investors began getting concerned that Iconix would default on this bond following news that retailers Walmart (WMT) and Target (TGT) were dropping some of its brands. Look how the bond market reacted...
The bond fell 50% in one day. The price recovered a bit over the next few days, but the bond still traded at a huge discount to par value (the $1,000 face value due at maturity). This is an example of where the bond market was wrong, and we quickly took advantage of the opportunity.
We knew the company well. We knew its problems were temporary. More important, we knew the value of its brands far exceeded its debt, and that the company would have no problem refinancing its debt. We recommended the bond in Stansberry's Credit Opportunities shortly after it collapsed.
In March, the bond was paid off in full. Investors who took our advice booked returns of more than 30% in around four months. That's an annualized gain of more than 85% with a "boring" bond investment.
How would you like to make more than 40% in 10 months?
We've recently recommended a bond with the exact same setup as Iconix that could make Stansberry's Credit Opportunities readers more than 40% in 10 months. Like Iconix, investors fear that it will default on its bond (due next May). But we're confident it will be able to refinance and pay off the bond.
Buying at today's prices, investors will earn a return of more than 40% in 10 months. The return is likely to be much higher than that if the bond returns to par value when the company refinances before May.
The point is, the bond market can be irrational, too. Investors tend to dump their bonds and ask questions later. Frankly, that excites us. When the market tanks, we have the data and systems in place to scoop up the safest opportunities for pennies on the dollar.
"Bigfoot" will be everywhere.
In the meantime, we're deploying our bond research to identify profitable "Golden Triangles." Stansberry's Credit Opportunities is the only newsletter in the world where you can capitalize on both strategies.
If you're interested in learning more about these profitable strategies, we've just put together a brand-new presentation. It includes an extremely limited-time offer to subscribe to Stansberry's Credit Opportunities at a steep discount to the normal retail price. Click here for the details.
Regards,
Mike DiBiase
Editor's note: When the next crisis hits, you'll have the once-in-a-decade opportunity to make huge triple-digit returns in the typically "boring" bond market... while taking much less risk than buying stocks. But only if you're prepared... and only if you know what to look for. That's exactly why Porter and his team launched Stansberry's Credit Opportunities. And right now, you can get three years for the price of one. But don't delay... The offer closes tomorrow at midnight. Learn more here.
