We're
approaching a period of vast credit default… There are two kinds of financial panic… The
only way to avoid bad debt… An upcoming shift from the leveraged and foolish to
the wise and patient…
I'm afraid if I keep writing about
the issues that concern me right now, you are all going to quit reading the
Friday Digest...Mondays are already our
highest-volume day for cancellations. And many people specifically cite the
Friday Digest as their reason
for canceling. Nobody likes to read bad news, especially about their savings,
their jobs, or their standard of living. But I can't help myself… If you're prepared, the next 12-36
months will be a great investment period for you – one of the three or four
best opportunities in the last 50 years. If you're not prepared, you'll
likely get wiped out. So I feel obligated to try, again,
to show you what I see in the markets right now.
We are approaching a period of vast credit default. Credit-market troubles are different
than equity market troubles. Credit-market troubles are "contagious"
and are amplified by leverage. Companies funded with equity go bankrupt and
nobody notices. But when companies (or countries) funded with huge amounts of
debt go bankrupt, it triggers a chain reaction. Institutions that would
otherwise be sound can end up in default because they've invested in toxic
debt. That's what's about to happen all
around the world.
Far, far, far too much money –
mind-boggling amounts – has been borrowed by people and countries that are not
creditworthy. These debts are going bad. The chain reaction is starting. And
nobody knows exactly what will happen next because the world has never seen so
much bad debt before. This will be the greatest legal
transfer of wealth in history.
Students have borrowed $1 trillion
for college. Most of these loans were used to purchase vastly overpriced
"online" education of highly dubious value. Consider that in 2000 –
just 15 years ago – the largest debt-funded college in the U.S. was New York
University, a highly credible, long-standing institution that serves smart and
ambitious students. At the time, former and current NYU students had $2.2
billion in student loans outstanding. Today, the leading debt-funded
college in the U.S. is the University of Phoenix, where $36 billion (yes, that
number is real) has been lent to current and former students, almost all of
whom received an online education.
Eight out of the 10 largest
debt-funded universities are online schools. I'd estimate the debts used to
fund these educations makes up around 80% of all outstanding student loans. These debts will never be repaid. And
the default tidal wave is starting right now.
Obama issued new rules in 2010 that
essentially gave students an option to not repay these debts. Millions have
chosen not to. (Shocker!)
These defaults are now spilling over
into securitized-debt packages worth hundreds of millions of dollars. They,
too, will default, damaging our financial system in ways no one yet understands.
Moody's is set to downgrade the first systemically important student-loan
asset-backed securities next month.
Big emerging markets with fragile,
corrupt governments (Mexico, Brazil, Turkey, and Greece) have borrowed
mind-boggling sums of money denominated largely in U.S. dollars. These loans
will all go bad. Brazil's currency has already fallen
by more than 40%. That's tantamount to its loan balances growing by 40% because
so much of its debt is denominated in U.S. dollars. The trouble is even worse in
smaller markets, like Malaysia and Indonesia, whose currencies are trading at
17-year lows. When you read about other countries'
currencies falling apart, you should know it will eventually harm our own
banking system and bond markets, which have financed all the debts…
Over the last decade, the
emerging-markets bond market has grown faster than any other debt market – by
more than 600%. In only 10 years, emerging-markets debts have gone from about
20% of the size of the U.S. high-yield market to roughly equal to our
high-yield market. That means a much, much higher percentage of the world's
fixed-income securities have significant currency and political risk than ever
before.
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. Since 2010, more than $500 billion worth of new
corporate debt was raised for U.S. onshore oil and gas producers. It's this
capital that financed the oil boom – which is responsible for all the net job creation
in the U.S. since 2009. 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. There
will be a huge opportunity for patient and liquid investors to buy tremendous
energy assets out of these defaults. But for the banks, insurance companies,
private-equity funds, and pension funds that provided this initial capital,
there's a tremendous amount of pain ahead. Expect major bank collapses in
Texas.
The auto-buying boom of 2010-2014
was financed with extraordinarily dubious subprime loans. Just look at General
Motors' books. Roughly 90% of GM car buyers finance their purchases. And as
recently as 2014, 83% of their loan book was subprime, with a shocking amount
categorized as "deep subprime." Deep subprime is essentially people
who don't have a credit rating or people who are currently in bankruptcy.
These loans were made using new,
much-longer terms – 72 and 84 months. Given the high interest rates on subprime
car loans (around 20%), these car "buyers" won't own any equity –
zero – in the cars until after month 60. Until then – five years down the road
– they have no economic interest in the vehicle they "own." These loans are the auto equivalent
of a subprime home buyer who used his mortgage as a piggy bank between 2004 and
2007.
By the end of last year, total auto
loans outstanding in the U.S. had reached almost $900 billion – up nearly 25%
in only two years. Does that sound wise? Loans that originated last year have
begun to default at a pace not seen since the 2008 financial crisis.
This problem is going to get a lot
worse. It will probably result in bankruptcy at Ford Motor and massive losses
to financial institutions that own these auto loans, like GM Financial and
Santander Consumer USA.
Even investors who aren't directly
hit by any of these ticking debt time bombs are going to be severely hurt by
the coming wave of debt defaults. That's because corporate America can rarely
resist taking a good idea (buying back stock) and making into a farce.
It should seem obvious to everyone
that buying back stock when its cheap (like in 2009) is a great use of a
corporation's free cash flow (earnings in excess of capital investments).
It should also be apparent to all
investors that borrowing huge sums of money to buy back stock after a six-year raging bull market
will likely cause severe financial problems sooner or later. That's especially
true when the company in question is already
highly leveraged and when it operates in highly cyclical industries or
industries whose earnings are largely dictated by borrowing costs (like real
estate).
Below, you will find a chart showing
five companies whose debt-funded buybacks over the past year go so far beyond
merely stupid that their actions cry out for an investigation of the management
team (and a complete replacement of their boards).
The people running these companies
are driving into a brick wall... and pressing harder on the accelerator.
How will you know if this dark view
of the world is correct? Just keep your eye on the exchange-traded funds (ETFs)
that hold vast quantities of speculative debt.
For example, I track the iShares
iBoxx High Yield Corporate Bond Fund (HYG) every day. I've been warning you
about it since May 2013. Since then, it has fallen from $95 to less than $85...
And it just made a new low. As long as this downtrend remains in
place, you can know for certain that I'm 100% right.
First, I know this for certain:
We're about to see a lot of big, wealthy investors panic when they realize how
much of this garbage they own. Believe me, anyone who is currently invested across the fixed-income markets will
end up taking losses on the bad debt I describe above because it makes up such
a large percentage of the total fixed-income universe. The only way to make sure you avoid
this stuff is to go to cash (short-term U.S. Treasury bonds) and gold.
Remember: Fannie Mae and Freddie Mac told investors they
didn't own any subprime debt. It was a total lie. They held hundreds of
billions of dollars of worthless mortgages. That will happen again with the bad
debt I describe above. When you hear a major financial
institution claim it doesn't own any emerging market debt or any subprime auto
or any student loans... don't believe it.
Second, unless you follow our work, you're going to suffer
the second kind of panic – you'll freeze up. You'll be too scared to buy
anything. I met a smart and talented financial
analyst at a December 2008 meeting in Hong Kong, right in the middle of the
crisis. He had been looking at parking garages in central Hong Kong – some of
the most valuable real estate in the world. The yields on the properties were
more than 20%. But he wouldn't buy. He admitted to me that he was too scared
that things would get even worse and no one would be able to afford to park
their cars. Don't make that kind of mistake.
The world isn't coming to an end. All that's going to change
is that these assets are going to shift from the leveraged and foolish to the wise
and patient. The next two or three years are
going to be terrible for most investors. But they can be GREAT for you. Buying bonds for pennies on the dollar is the
absolute best way to make a fortune in the markets.
That's why I plan to re-launch our high-yield,
distressed-debt investing newsletter. Our previous product, True Income, had an amazing run
during the last crisis. It earned huge returns for investors who were wise
enough to follow our lead in 2008, 2009, and 2010 buying bonds for pennies on the
dollar while other investors panicked.
We made more money buying distressed
bonds – see the Rite Aid bond returns below in our Hall of Fame – than most
people ever make in stocks. And
we're going to do it again over the next three years. Stay tuned for details
about our new product. (By the way, we're trying to decide
what to call this new service. I like Stansberry
Distressed. Our editor in chief likes Stansberry Credit Analyst. Which do you like? Do you have any
other ideas? We'd love to hear from you at feedback@stansberryresearch.com.)
But please do me a favor: Send today's Digest to anyone you care about who
you worry might have exposure to the bad debts I describe above. If you're reading this Digest because someone sent it to
you, please visit our website www.stansberryresearch.com
and browse our investor-education center to learn more about the way we
approach investing. We'd love to have your business.
New 52-week highs (as of 9/24/15): none.
We have a light mailbag this week. But I'd love to hear your
thoughts on today's Digest.
What are you doing to make sure the next two to three years are great investing
years for you? How are you protecting yourself? Let me know at feedback@stansberryresearch.com.
"Please note that the DOL web site shows that ONLY
5,469 people commented on the proposed regulations. I received an e-mail from
my online brokers (thinkorswim/TD Ameritrade) a couple weeks ago suggesting
that we contact our local congressional representative. Perhaps it would be a
good idea to suggest that in the Digest
for everyone that didn't see the article in the Digest before the 11:59 PM ET deadline.
Thanks!" – Paid-up subscriber Chris Vogt. Regards, Porter Stansberry, Baltimore, Maryland September 25, 2015
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