Editor's note: Investors are looking for safe ways to put money to work. That's why we're hosting a Gold Rally Kickoff Call with one of the world's foremost gold stock investors...
This upcoming Monday at 9:30 a.m., John Doody will go public with his 2020 outlook for gold. He plans to cover why the recent surge in gold could be just the beginning – and discuss the best way to grow and protect your wealth in this space. You can join us at www.StansberryGold.com.
Moving on to the Weekend Edition: Today's essay is adapted from the April issue of Stansberry's Credit Opportunities. Mike DiBiase believes that tremendous investment opportunities lie outside of the stock market... But he wants to caution readers on how to invest safely in the absence of "normal" today. Read on for the details...
No matter how hard you try, you can't un-pop a bubble...
I'm talking about the corporate-debt bubble.
As I'll explain today, it's finally popping after years of excess...
Mortgage debt was the bubble that caused the last financial crisis. This time, the bubble is corporate debt. U.S. companies owe a record $10 trillion today. Mortgage debt is up only 9% since 2008... But corporate debt is up 75% in the same span.
Meanwhile, the credit quality of corporate debt is at an all-time low. Around one out of every five companies struggle just to pay the interest on their debt.
In short, corporate America can't afford a recession...
More than 26.5 million Americans filed for unemployment over the past five weeks. That's around 20% of the workforce. That's double the peak unemployment rate during the last financial crisis. And it's going to get worse before it gets better...
Economists at the Federal Reserve predict the unemployment rate will hit 32%. And even if all the "shelter in place" directives across the U.S. ended tomorrow, it's naïve to think that all these unemployed folks would find work immediately.
The Federal Reserve and the U.S. Treasury are using every weapon in their arsenal to prevent it. Since the middle of March, they've unleashed more than $5 trillion in financial stimulus. Expect more in the months ahead, including a $2 trillion infrastructure bill.
Investors seem confident that these efforts will work...
The benchmark S&P 500 Index is up about 25% from its March 23 low. It's now back in bull market territory – at least by the common "20% move higher" definition.
It's the same story with debt investors... The largest investment-grade and high-yield bond exchange-traded funds are up around 15% from their lows in March.
Many folks believe that once the coronavirus pandemic is behind us and everyone returns to work, things will go back to normal.
Investors are partying on the deck of the Titanic. But I think they're making a big mistake...
The global economy is suffering a heart attack. It has been shut down for nearly two months so far... something that has never happened before. Plain and simple... we're not returning to normal anytime soon.
No matter what reinflating magic the Fed tries, it won't work.
With the economy shut down, nearly every business is doing one or both of the following...
- Burning through cash
- Taking on additional debt
Many companies are being forced to borrow just to pay salaries and other basic expenses. Their cash balances are getting smaller, and their debts are growing larger and larger by the day.
Here's an important point to remember about the Fed's crisis-averting stimulus efforts...
Aside from the airlines and small businesses, companies eligible for the central bank's bailouts to date aren't getting free money. They're not handouts... They're loans that must be paid back.
The Fed is stepping in when no one else will loan money to these companies. The bailout is doing nothing more than adding to the already record amount of U.S. corporate debt.
And it's not lending money to just any company... It's only lending to companies with investment-grade credit ratings or companies that were downgraded from investment-grade after March 22.
Investment-grade credit ratings are anything from "AAA" to "BBB." Non-investment-grade – or "junk" – credit ratings are "BB" and lower. Here's a breakdown...
To qualify for the Fed's loans, a company that was downgraded after March 22 must maintain a rating of at least a "BB-," according to credit-ratings agency Standard & Poor's (S&P).
But the thing is... the companies that most need the help are the junk-rated companies. And the Fed isn't doing anything to help them.
Shutting down the economy for at least two months has severe ramifications on companies' credit ratings...
As their debt piles grow larger, corporate profits will fall dramatically this year. That means companies' debt-to-earnings ratios are about to skyrocket, which will lead to an increasing number of credit downgrades. We're already starting to see that happen...
In the first quarter, S&P downgraded 739 North American companies. That's more than any quarter during the last financial crisis. Look at the quarterly breakdown below...
And so far in April, S&P has downgraded another 531 companies for a total of 1,270 this year. It downgraded 906 companies last year. In other words, we've already seen more downgrades than in all of 2019, and we're not even halfway through the year.
At the peak of the last financial crisis, S&P only downgraded 1,500 companies in a single year. If the current pace continues through the rest of 2020, we'll see roughly 4,000 downgrades. That's a staggering number.
This is important because downgrades always precede defaults. (That's when a company can't pay its interest or principal as it comes due and must file for bankruptcy protection.) After experiencing downgrades, companies must pay higher interest rates to borrow.
So in turn, we can expect defaults to soar in the months to come...
S&P currently forecasts a 10% high-yield default rate. That's the percentage of companies with junk credit it expects to default within 12 months. Its current "pessimistic" forecast projects the default rate to reach about 13% by the end of the year. That would be a new 40-year high.
The default rate is a critical number... When it begins to soar, investors become fearful. They want nothing to do with high-yield bonds. The junk-credit market can dry up quickly.
The last time that happened was in December 2018, when investors were worried about rising interest rates. Companies with junk credit had no one willing to lend them money. So the Fed began lowering interest rates in an attempt to stop the bleeding.
It worked... But don't expect the Fed to save the day today like it did in 2018. We weren't dealing with a global recession then. And the Fed has already lowered rates down to zero this time.
Chairman Jerome Powell said earlier this month that the Fed can only lend to "solvent" companies. So don't expect the central bank to bail out any junk-rated companies.
Things are going to get much worse for junk-rated companies with large amounts of debt maturing this year. The sins of their debt binge will finally catch up with them. And as the number of bankruptcies starts to escalate, investors will want nothing to do with junk debt.
Irreparable damage has been done to the economy. And the longer the shutdown lasts, the worse it will be. For the most leveraged companies, it's a death sentence.
Unfortunately, many investors haven't yet seen the destruction. Like a tornado that struck in the middle of the night, the damage has been hidden from view.
However, over the next few weeks, we'll get a much better idea about the extent of the damage done so far. As companies continue reporting first-quarter results, I believe the numbers will be much worse across the board than most people expect.
And keep in mind, this is just the beginning...
The shutdown only impacted a few weeks of the final month of the first quarter. The second quarter will be much worse, since shelter-in-place orders will have been in place for longer.
It's possible some businesses could be shut down for many more months. And even if businesses are allowed to reopen soon, a second wave of the virus could shut everything down again.
For now, the Fed's unprecedented stimulus has given new life to the markets. But don't be fooled... Just because the markets are up and high-yield credit spread is falling today, it doesn't mean the storm clouds are gone.
Regards,
Mike DiBiase
Editor's note: You don't have to be a victim... Safe, distressed-debt opportunities – exactly what Mike covers in Stansberry's Credit Opportunities – are cropping up in response to the recent market crash. The last time the market looked like this, one of our paid-up subscribers made a killing on these "crisis bonds." And he recently revealed all the details... including how our Credit Opportunities strategy helped him retire at age 52. Click here for the full story.
