Editor's note: Things are changing fast these days... So as a break from our usual fare, we're sharing a piece from Stansberry's Credit Opportunities editor Mike DiBiase. It combines key insights from his recent Stansberry Digest essay with his latest updates on what's happening in the credit markets – and the biggest threat to your wealth right now...
At least for now, stocks are on the rise again after the first bout with the coronavirus crisis...
Since its March 23 low, the S&P 500 has carved out a 23% gain. But sentiment remains on a hair trigger. We're still seeing big price swings up and down... And the CBOE Volatility Index (or "VIX") has remained above 40 since late February.
The "unknown" is still weighing on investors' minds. As the Wall Street Journal noted last month...
The number of canceled conferences and travel has continued to rise as the virus has spread, crimping business activity and spending while roiling the outlook for global growth this year. Investors and analysts have slashed their outlooks for corporate profits this year. Many have been worried that the virus will harm consumer sentiment and business investment, though the true ramifications of the sickness remain unclear.
The virus – which originated in central China – has now spread to every continent except Antarctica. The number of confirmed cases worldwide is now roughly 1.5 million. And the death toll keeps rising, too.
COVID-19 is an unprecedented, "black swan" event. No one saw it coming. And we'll continue to cover it in the coming days, weeks, and months.
But as economist and author Peter Schiff recently reminded us, investors are missing that the coronavirus is merely the "pin" and not the "bubble." Schiff is famous for predicting the last financial crisis long before it happened. But the "bubble" this time isn't mortgage debt...
It's corporate debt.
Everyone is busy focusing on the pin today. That's understandable. But we can't lose sight of the bubble that it popped.
As the editor of our bond newsletter, Stansberry's Credit Opportunities, I spend a lot of time studying debt. And I get it... it's easy to stick your head in the sand and not think about it.
But that's a big mistake...
The global lockdown to "flatten the curve" and curb the spread of coronavirus is wreaking havoc on the economy. But ultimately, I believe excessive debt will be responsible for the worst of the damage during this crisis... with far more severe and long-lasting consequences.
Today, I'll show you why.
First, Schiff isn't the only one who saw the bubble in corporate debt. Our founder Porter Stansberry warned about the hidden dangers in corporate debt more than four years ago...
Porter often sees things long before anyone else...
And he's willing to say things that folks in the mainstream financial media won't say.
For example, back in 2007, Porter warned again and again that "blue chip" carmaker General Motors (GM) would go bankrupt.
Then, in June 2008, Porter predicted that the world's two largest mortgage bankers – Fannie Mae and Freddie Mac – would also go out of business within a year.
Many subscribers thought he was crazy. These two giants of American capitalism could never go bankrupt. But in both cases... that's exactly what happened.
I've learned a lot from following Porter's work over the years, but one thing stands out above it all... While you might not always like his predictions, when he's passionate about something – like he was with GM and the mortgage bankers – he's usually right.
Back in 2015, Porter made several big predictions in an important Stansberry Digest essay. As you'll see, he once again got a lot of things right. But not everything... at least not yet.
So now, let's examine his predictions and see if they came true...
In his 2015 Digest, Porter specifically predicted the pain for the oil and gas industry. As he wrote...
Nearly all the growth in the U.S. high-yield bond market over the last decade is related to oil and gas exploration and production... These debts cannot be repaid with oil prices at less than $60. And yet they're all coming due between 2016 and 2020.
As these debts go bad, even major oil companies will see their bonds downgraded and their dividends cut... for the banks, insurance companies, private-equity funds, and pension funds that provided this initial capital, there's a tremendous amount of pain ahead.
From 2011 to 2014, many energy companies levered up when a barrel of oil cost more than $100. They were greedy... betting that oil prices would never get cheaper again.
But by September 2015, oil prices were in a freefall...
As the U.S. shale industry flooded the market with cheap supply, oil prices quickly plunged from their peak. And in the past four-plus years, prices have averaged about $53 per barrel.
Oil and gas bankruptcies in the U.S. skyrocketed, peaking in the second quarter of 2016 – just months after Porter's warning...
I'd say Porter nailed that part of his first prediction.
Porter also warned about auto loans going bad – and the pain that would cause for investors...
He predicted "massive losses" for companies that owned these loans – like Ford Motor (F), General Motors' financing arm (GM Financial), and Santander Consumer USA (SC).
Altogether, these three stocks have fallen 20%, on average, since Porter made his prediction. That's abysmal, considering the benchmark S&P 500 Index's 54% return in that stretch...
You're likely most familiar with the first two of these auto giants. GM's sales dropped 7% last year, while Ford's revenue fell 3%. At the same time, their combined debt has soared from $63 billion in 2015 to more than $250 billion today.
Plus, these two companies' massive pension liabilities total $150 billion. The combined debt and pension liabilities of these two automakers is five times more than their market value.
I'd say Porter nailed that prediction, too. And as he said in his original essay... "This problem is going to get a lot worse." I don't think this part of the story is over yet.
Porter also predicted a wave of corporate credit defaults in the coming years...
We haven't yet seen a broad wave of corporate defaults... at least not yet. But I believe Porter will be proven correct once again.
We're going to see a wave of defaults beginning this year...
U.S. companies have never been more indebted in history. Corporate debt is higher than it's ever been, both nominally and as a percentage of gross domestic product ("GDP")...
And not only is the debt pile much larger, its quality is far worse, too.
This bubble is about to pop.
The coronavirus has caused fear to replace complacency in the markets. The best way to measure this is by looking at the high-yield credit spread. It's the difference between the average yield of so-called "junk" bonds and the yield of similar-duration U.S. Treasury notes. When the spread is high, it shows high levels of fear.
The spread soared from around 350 basis points ("bps") in February to nearly 1,100 bps last month. It's since come back down to around 900 bps... But that's well above its long-term average of around 600 bps. In other words, the high-yield credit market is still spooked.
We expect it to go even higher... During the last credit crisis back in 2008, the credit spread peaked at 2,200 bps. As the default rate climbs over the next few quarters, S&P believes the credit spread will approach 1,600 soon.
This is a problem because bond prices and bond yields are inversely related. A soaring bond yield means bond prices have collapsed. It also means the cost of borrowing for new junk borrowers has soared.
Many of these borrowers can barely afford the interest on their debt today. What do you think will happen when their cost of borrowing suddenly doubles or triples?
And it gets worse for junk borrowers... The credit markets aren't as liquid as the equity markets. They can dry up quickly.
That happened very briefly in December 2008 when the stock market fell by nearly 20%. We're already starting to see it happen again. Take a look...
Back in 2018, the Fed began lowering interest rates in an attempt to stop the bleeding. It worked. But we weren't dealing with a global recession then. And the Fed has already lowered rates to zero today.
The shutdown of the global economy is devasting for businesses. The sudden and dramatic loss of revenue means many companies are burning through cash and taking on debt faster than ever before, just to keep their doors open. The longer the shutdown lasts, the worse the damage is going to be. There will be carnage when the tide rolls out. It's a death sentence for the most leveraged companies.
In short, the past sins of the corporate-debt binge are finally catching up to us. We'll soon see bankruptcies soar as it unfolds.
The good news is, you don't have to fall victim to the pandemic economy...
As the editor of our distressed-bond service, Stansberry's Credit Opportunities, we've been preparing for this credit crisis. And as an investor, you should start preparing for what's coming, too.
We've already helped our subscribers earn impressive returns since Porter's initial predictions in 2015...
Since we launched Stansberry's Credit Opportunities in late 2015, we've closed 26 bond positions (an 81% win rate) with an average annualized return of 17%.
That's more than double the 7% annualized return of the overall high-yield bond market – as measured by the iShares iBoxx High Yield Corporate Bond Fund (HYG). And we've even beaten the 15% annualized return of the S&P 500 over that span... while taking on far less risk.
There's no better time than now to start looking for safe investments. While you're waiting for smart investing opportunities to crop up in stocks, you can look to bonds to grow your capital.
So if you're worried at all about the markets, I encourage you to get started right here.
Regards,
Mike DiBiase
Editor's note: Uncertainty is high today... But you can still earn big, safe returns on your capital, while many investors are stuck sitting on the sidelines. In Stansberry's Credit Opportunities, Mike shows that investing in bonds is a critical and dependable strategy to put your money to work outside of the turbulent stock market... with outsized potential gains. Learn more here.
