Editor's note: Today's Weekend Edition is an adaptation of a July Masters Series essay, which was originally published as a special report for Stansberry's Credit Opportunities subscribers. In it, editor Mike DiBiase explains why the current state of the markets is going to end badly for most investors and details how this pandemic-driven credit cycle is different from the last financial crisis.
It started out like a normal video interview...
Adam Aron – the CEO of troubled movie-theater chain AMC Entertainment (AMC) – appeared on camera from his home in a shirt and tie to answer questions from popular investment YouTuber Trey Collins.
It was all very professional. That is, until Aron's camera accidentally fell off his computer while he was talking... showing everyone watching that he wasn't wearing any pants.
Aron quickly grabbed the camera and put it back into place. He kept going as if nothing had happened, hoping that no one noticed...
Of course, people did notice. The video instantly became an Internet meme. But instead of being ridiculed, Aron became even more loved by his legion of followers – investors who call themselves "Apes." The hashtag "ApesDontWearPants" went viral.
This ridiculous moment perfectly captures the current state of the markets...
AMC was just weeks away from filing for bankruptcy when members of the "Ape Army" – armed with stimulus checks and unemployment cash burning holes in their pockets – came to its rescue.
Retail investors are at the forefront of the "meme stock" craze. They join together to buy heavily shorted, left-for-dead stocks, aiming to drive up the share price by causing a "short squeeze" – forcing short-sellers to buy shares to cover their positions at much higher prices.
The COVID-19 pandemic crushed AMC's business. Attendance was down 91%, and the company had burned through nearly all of its cash.
AMC's stock traded for less than $2 at the beginning of January and was headed for zero when the Apes began targeting it. They pushed up the stock price 10-fold to $20 per share on January 27, valuing the company at $8 billion, AMC's highest-ever valuation at the time.
The Apes continued to pile into the stock. The day before Aron sat down pants-less for his YouTube interview, AMC's stock traded as high as $72 per share, valuing the company at $36 billion.
AMC is no longer in danger of bankruptcy. Aron used the lunacy of retail investors to line his company's coffers with cash by selling new shares of stock.
AMC's stock has come back down since then, but it still has a market cap around 30 times larger than it did prior to the pandemic.
Take a look...
Most of the Apes paid extravagant prices for shares of AMC as it surged to record highs. Odds are that their foray into the movie-theater business will end poorly.
But that's the point we've reached in the markets...
It's not just meme stocks. Thanks to the Federal Reserve and the U.S. Treasury, we're seeing a liquidity-driven speculative frenzy in almost everything – from a cryptocurrency that started as a joke (Dogecoin) to video clips of flying babies and digital cats (non-fungible tokens) selling for millions of dollars.
Folks have gotten greedy, and they're losing discipline. It's going to end badly for them.
What most people don't realize is that there is tremendous risk in the market today.
With the economic downturn caused by the COVID-19 pandemic, corporate debt piles have grown fatter than ever... The pandemic caused corporate debt to increase $1 trillion last year to more than $11 trillion today – the highest it has ever been. It has nearly doubled since the last financial crisis.
The only reason companies can afford this record debt is because of the Fed's near-zero interest-rate policy over the past decade. But debt has grown so large now that even with near-zero interest rates, many companies are choking on their debt...
Companies that don't earn enough profits to pay for their interest costs are called "zombies." They have no hope of ever paying off their debt. Today, one out of every four public companies is considered a "zombie."
Corporate credit quality is at an all-time low...
The percentage of corporate borrowers who have credit ratings below investment grade – in other words, "'junk" credit – is now at an all-time high of 58%. Said another way, nearly six out of every 10 borrowers in the U.S. have dubious credit ratings. That's up from 43% in 2004.
Here's why that's important... The default rate increases dramatically the further you go down the credit ladder. These are the borrowers who are much more likely to default.
To put it simply, corporate debt has never been larger or more burdensome than it is right now.
The truth is, many companies have only been able to keep paying their bills during the pandemic by borrowing. But you can't borrow yourself out of a crisis...
This historic amount of corporate debt can't go unpaid forever.
A lot of attention has shone on the winners of the "pandemic economy." But for many companies, the shift to a more digital world – as consumers continue to spend time and money differently than they did before – means sales and profits may never reach pre-pandemic levels again... And that means the prospect of repaying or refinancing this mountain of debt becomes less plausible every day...
This leads me to believe much of this debt won't ever be paid back.
The only way out of this debt hole for these companies is bankruptcy. I'm confident we'll see the collapse of many companies in the months and years ahead.
Last year, 146 U.S. companies defaulted on their debt, according to credit-ratings agency Standard & Poor's (S&P). That's the highest number of defaults since 195 companies defaulted in 2009 during the last financial crisis.
In a normal credit cycle bottom, all of the bad debt from the excesses of the cycle gets wiped away, leaving corporations with less leverage. That's what we saw during the last financial crisis... But that didn't happen this time.
Corporate debt hasn't fallen... As I said, it has grown even higher than ever before.
Excessive debt balances can only continue to rise for so long. Eventually – and in most cases, suddenly – companies will collapse.
We are approaching a new credit crisis where many companies will fail and bond prices will plummet. Unsuspecting investors will be wiped out.
It's more important now than ever to not lose discipline... or get caught up in the meme-stock mania. Avoiding the market's zombies – in all their forms – should be your No. 1 priority in today's frenzied markets.
Editor's note: Mike sees a credit collapse on the horizon... And those who don't know it's coming will be hit hard. But Mike says by investing outside of traditional stocks – in assets protected from the market frenzy – you can make once-in-a-lifetime returns using one technique... while nearly everyone else is watching their hard-earned wealth disappear. Learn more about this strategy right here.