Editor's note: While others are worried, you should be ready to pounce...

Credit Opportunities editor Mike DiBiase explains that whenever a "credit crisis" strikes, the strategy he employs truly shines.

Today's Masters Series comes from an interview with Digest editor Corey McLaughlin. In it, Mike explains why he thinks the next credit crisis might be just around the corner... and why it's one of the best times to profit.

The Best Time to Buy Is When a 'Credit Crisis' Hits

An interview with Mike DiBiase, editor, Credit Opportunities

Corey McLaughlin: Your corporate-bond strategy produces its highest returns during a "credit crisis." Why is that?

Mike DiBiase: A credit crisis is a period when interest rates rise, bankruptcies soar, and credit tightens. Heavily indebted companies that were able to refinance their debt as it came due suddenly have to do it at much higher interest rates and with stricter lending standards.

More and more companies will see their credit cut off or restricted and go "belly up." That's when investors realize that the bonds they are holding have real default risk.

When fear takes over the bond market, investors want nothing to do with bonds. Since the corporate bond market is far less liquid than the stock market, bond prices fall hard. Other investors see falling prices and panic. This causes contagion. They sell their bonds, too, even the safe ones.

Bonds that once traded around par value ($1,000 per bond) suddenly trade at deeply distressed prices – $800, $700, $600, $500, and sometimes even much lower.

The lower the price, the higher your return. That's why a credit crisis is the very best time to buy a bond.

For example, if you buy a bond that pays a 7% interest coupon for $600, that's now a 12% cash interest yield on your $600 purchase price. And as long as the bond is safe and will pay you your principal at maturity, you'll earn a $400 capital gain, too ($1,000 par value of the bond less your $600 purchase price).

In normal times, that was a fairly boring 7% yielding bond. But let's assume you bought it for $600 during a crisis and it had only three years left to maturity. Your total return, including three years of interest payments, would be more than 100%. Buying it at that big of a discount would nearly quadruple your annualized return to 27%.

That's a stock-like return from an investment that has legal protections.

CM: How do you know when we are in a credit crisis?

MD: The best way to measure it is with the high-yield spread. The spread is the difference between the average yield on high-yield bonds and the yield of similar-duration "risk free" U.S. Treasurys.

"High yield" is the term for the riskier end of the credit spectrum for bonds. It's like non-prime when talking about consumer credit. The companies that issue high-yield bonds tend to have more debt and a harder time affording their interest payments.

It's measured in basis points ("bps"). If bonds are yielding 7% and Treasurys are yielding 4%, the spread is 300 bps.

The spread compensates investors for the default risk of corporate bonds. In theory, U.S. Treasurys carry no default risk. So corporate bonds are riskier and pay you more to assume that risk.

When the spread is low, that means investors aren't getting paid much more for holding junk bonds than they do for holding "risk free" Treasurys. When the spread is high, returns for corporate bonds are high.

The spread has averaged around 500 bps over the past 25 years. You know you are in a credit crisis when the spread spikes to more than 1,000 bps.

CM: What's the high-yield spread today? Are we nearing a credit crisis?

MD: The high-yield spread is extremely low today, at around 270 bps. This is far below average. It means investors are not getting compensated for the default risk they are assuming. It also means bond prices are high. And since bond prices and bond yields are inversely related, that means bond yields are low.

Looking at the spread tells you the risk appetite of investors and whether bonds are expensive or cheap at any given time. But a low spread doesn't mean we aren't nearing a credit crisis.

The spread can rise fast. The high-yield spread was even lower than today in the middle of 2007, at around 250 bps. That wasn't long before the housing market started to unravel. And it was a little more than two years before the worst of the last credit crisis.

CM: It's always stunning to me – though maybe it shouldn't be – just how many companies can be considered "zombies" today. What's the deal with that? And in a roundabout way, I guess they actually help create the types of opportunities in good businesses that you look for. Is that right?

MD: Exactly. Today, around 21% of U.S. companies are considered zombies... companies that can't afford the interest on their debt.

Nearly 1 out of every 5 companies is a zombie. That's down slightly from a few years ago, but it's higher than before the last financial crisis.

These companies are living on borrowed time. They're dependent on creditors who are willing to lend them more money when their debt comes due.

The next credit crisis or recession is going to bury many of them. Zombies are already choking on today's higher interest rates and inflation. An economic downturn will be the final nail in the coffin. And when credit tightens, they'll no longer have life support.

And when investors see a big wave of bankruptcies, they start selling their bonds, even safe ones.

CM: OK. So how close do you think we are to the next credit crisis?

MD: We are long overdue for one. Normally they happen around every 10 years. The last true credit crisis occurred in 2008. That's almost 20 years ago now.

We would have had one during COVID-19 if the Federal Reserve hadn't stepped in and injected massive amounts of liquidity into the system.

After the World Health Organization declared COVID-19 a pandemic in March 2020, the high-yield spread suddenly spiked to more than 1,000 bps. My colleague Bill McGiltion and I jumped on the opportunity and recommended eight bonds within a span of a few weeks while the spread was wide.

The Fed stepped in with unprecedented monetary stimulus and calmed the market. The wave passed almost as quickly as it came and the spread narrowed. We were able to close all eight positions above par value in less than a year, holding them just 112 days on average. The average annualized return of those eight bonds was 59%.

To answer your question, my current prediction is that the next true credit crisis will arrive in 2028.

CM: That's interesting. Why do you believe that?

MD: Because I follow the money supply.

It's why, back in 2021, I knew inflation was headed much higher before nearly everyone else. Back then, inflation was still at less than 2%.

I wrote a Digest in April 2021 saying that inflation was the biggest threat to the markets. The Fed had just printed more than $4 trillion of new money since the beginning of the pandemic. That added 30% to the money supply, an unprecedented increase in such a short time.

It's really simple... Big increases in the money supply cause inflation.

The late Nobel Prize-winning economist Milton Friedman said it best... "Inflation is always and everywhere a monetary phenomenon."

According to Friedman, inflation is always caused by the same thing – a more rapid increase in the amount of money than in the output of goods and services.

It takes time for money-supply increases to make their way into the economy. That's why we didn't see rampant inflation right after the pandemic.

But as we all know, inflation eventually soared to as high as 9% in 2022. That was the government's official number. I think it was much higher.

The Fed learned its lesson and started decreasing the money supply in 2023. Inflation came down.

But since the beginning of 2024, the money supply began increasing again, slowly at first. It has now increased for 26 straight months. And here's the troubling part... Those increases have been accelerating.

The money supply increased around 5.6% year over year in both May and June, its fastest monthly increases since 2022.

By the middle of 2027, I believe these money-supply increases will begin pushing inflation higher again. Inflation has already been rising because of soaring oil prices caused by the war in Iran. But even without the temporary supply shocks, I believe inflation was headed higher anyway.

CM: You never hear politicians talk about the government's role in fueling inflation. It's always something else...

MD: Of course not. Why would they admit it? Folks today don't seem to understand this. They're being fooled by the Fed's smoke and mirrors. The Fed wants you to believe inflation is caused by supply-chain problems... or rising gas prices. Most people think that once the conflict is over, oil prices will fall and so will inflation.

I'm not saying those things have no effect. They do. But they aren't the root cause of the problem. They're just making inflation a bit worse than it would have been.

CM: OK, but how will that cause the next credit crisis?

MD: Higher inflation means investors demand higher interest rates.

As inflation heads higher, it will cause interest rates to move higher, too. And higher interest rates will break the economy.

Most folks think that interest rates are lower today since the Fed began cutting rates in September 2024. The Fed has lowered the short-term federal-funds rate it controls by 150 bps.

It's not true. The lower federal-funds rate hasn't affected long-term rates one bit. In fact, long-term rates have increased since the Fed began lowering rates.

I'm talking about the 10-year and 30-year Treasury rates. And these are the interest rates that matter most to businesses and consumers. These rates affect the interest you pay on credit cards, mortgages, and business loans.

The 10-year Treasury rate has increased by more than 100 bps, and the 30-year Treasury has increased by 125 bps since the Fed began cutting rates. The 30-year Treasury is now more than 5.2%. The last time the rate was more than 5.2% was 2007, right before the last credit crisis.

In short, the Fed's actions have backfired. The only way it can get long-term rates down is by buying loads of long-term Treasurys.

This is known as quantitative easing ("QE"). The Fed has to print new money to do it.

The problem is, turning on the money fire hose might seem like a good idea in the short term. But it always leads to more pain. It will make the inflation problem even worse.

Higher interest rates and inflation will kick-start the next true credit crisis.

CM: It sounds like the Fed will be backed into a corner.

MD: That's right. It'll be left with two choices... higher interest rates or higher inflation. Both are deadly for our economy. It's a lose-lose situation.

If the Fed doesn't step in with QE, interest rates are going to continue going higher, leading to more bankruptcies, tighter credit, and eventually a recession.

But if the Fed floods the market with more liquidity and prints more money to buy down long-term interest rates, that will cause even worse inflation, which will also trigger a recession.

The only way to bring down both interest rates and inflation is to reduce the money supply, tighten credit, and let higher interest rates clear out all of the bad debt that is in the system. In other words, let the credit crisis play out and do its job.

The Fed is out of bullets. That's why I think we're going to see the next credit crisis very soon. Many companies will go bankrupt and bond prices will plummet. This is the moment we've been waiting for since launching our newsletter in 2015.

We'll be able to recommend safe bonds for pennies on the dollar. It will be the kind of opportunity that comes along once in a generation.

Don't get me wrong... I don't want to see our economy tank. I'm not looking forward to seeing people in economic pain. But the excesses of the past few decades have led to a ton of bad debt that needs to be cleared. In the long run, it will be good for our economy.

We can't defer the pain forever. I want regular investors to know there's a way they can at least profit from the coming crisis.

Editor's note: With debt increasingly becoming more expensive, many companies will no longer be able to afford to service or refinance their debt... leading to a wave of companies going bankrupt and setting off a contagion in the credit market. That's the signal Mike and his Credit Opportunities team are looking for.

They use a strategy that focuses on investments with equity-like returns – without the risks that stocks introduce. And now you can learn how to put this strategy to work. Click here to learn more.