A Huge Decline in Fear
A huge decline in fear... Investors are euphoric... But credit defaults soar... And bank stocks crash... Who's right?... A broad economic review... P.J. O'Rourke: Bedtime in Cleveland…
Editor's note: Be sure to read to the bottom of today's Digest for a special dispatch from best-selling author and Digest contributor P.J. O'Rourke… who shares his thoughts on the Republican Party's circus this week in Cleveland.
You'll have to forgive all of the economics in this week's Friday Digest. I (Porter) don't normally put my "economics hat" on in public, because I know nothing is more boring than reading a review of economic indicators.
Also most of the time, economic indicators don't tell you much about what's going to happen in the markets. It takes at least a year of data in the most important data sets (industrial production, trade, employment) to create any meaningful correlations.
So... why am I spending so much time on economic data this week? Because for the first time since the last recession, we now have clear evidence that a global recession is unfolding. The data aren't ambiguous anymore.
Ironically (and not surprisingly), most investors don't see a single cloud on the horizon. Over the last three weeks, the Volatility Index ("VIX"), which measures how much investors will pay for options that protect the value of their stocks (and thus reflects fear in the markets), has fallen faster than at any time in history.
Just three weeks ago, the VIX spiked to almost 30 on fears that the "Brexit" vote would result in a severe European banking crisis. But... as if by magic... the stock market shrugged off those fears and rallied. And the VIX simply collapsed. Based on this index, you'd have to say that investor sentiment is pretty near euphoric.
Meanwhile, we saw the most convincing evidence to date that a new credit-default cycle has begun. According to Standard & Poor's credit-monitoring service, global credit defaults hit the "century mark" last week. That is, since the start of 2016, 100 different corporations around the world defaulted on their debts. These defaults put $154 billion worth of assets in jeopardy, and they wiped out equity holders.
The number of companies defaulting on their debts is 50% higher than it was over the same period last year. Credit-ratings agency Moody's now estimates that the default rate on noninvestment-grade corporate debt will reach 6% by the end of this year, confirming that a new default cycle has begun. If corporate defaults continue at this pace, more than 200 companies will go bankrupt by the end of the year, a nominal amount that will surpass the previous all-time high set in 2009.
In other words, conditions in the market for corporate credit are now on track to be worse than they were in 2009.
You might remember that I've been warning since late last year that a new, rising default cycle was underway. Once these "default dominoes" start falling, they don't stop for two or three years. As defaults rise, interest rates on corporations around the world will increase and the availability of credit will be reduced... causing still more defaults.
These default cycles happen periodically (usually every five to seven years) and always disrupt the markets. If a company's debt can't be repaid or refinanced, the shareholders get wiped out. And given the extreme amount of debt that has been underwritten globally since 2009, it's not hard to see that this new default cycle is going to cause severe losses. Marty Fridson, the "dean" of corporate debt in New York, predicts almost $2 trillion in losses in the world's corporate bond markets by 2019.
I've labeled this coming period of credit distress "the largest legal transfer of wealth in history." Over the next 18-36 months, millions of investors in leveraged businesses will be wiped out. But investors who own the more senior parts of the capital structure (senior bonds) will end up owning the assets of these companies. Purchased at the right price, distressed corporate debt can make a fortune for investors during periods like we're experiencing right now. (Just see our track record in Stansberry's Credit Opportunities. The positions in our model portfolio are up 18% on average, and we only launched the service in November.)
But the exact opposite is true for equity investors. They almost always get wiped out in bankruptcy.
So... who do you think is right? Is it the equity investors, who are euphorically bidding up stock prices, despite falling earnings and rising defaults? Or is it the cautious bond-market investors, who continue to view the market with deep skepticism and caution? Over the last year, the Dow is up 5.5%... while high-yield bonds are down 1.5%.
Here's a quick review of the data bond investors find so troubling... and that so far equity investors seem to be ignoring.
You'll recall that we published a chart last week showing how U.S. industrial production had suddenly begun to decline, parting ways with the rising S&P 500. Industrial production has now been falling for three quarters and has declined in 14 out of the last 19 months.
Why does that matter? Well, because going back to 1920, every annual decline in industrial production has led to a recession. Currently, industrial production is running 0.7% below last year. That might not seem like much, but it's a bigger drop than the ones that preceded 16 of the past 17 recessions.
Then there's exports. U.S. exports have been falling steadily since peaking in October 2014, with sharp declines seen since July 2015. Currently, U.S. exports ($182 billion in May) are down 5.2% since last year. Once again, a decline in exports is a strong signal of an approaching recession. The last two times we saw U.S. exports decline (2001 and 2008) marked the beginning of a recession.
Global trade has been dropping sharply since 2014 and continues to decline, falling 1.1% quarter over quarter in the first quarter of 2016.
Especially noteworthy are the large, ongoing declines in China's exports. China's exports are down 4.1% annually, according to the latest monthly trade data (May). China's gross domestic product (GDP) growth is tightly correlated with its export economy.
It's not plausible that China's GDP could grow given these sharp declines in trade. That's going to be a big problem because no market, not even the U.S., has added more debt to its economy since 2008 than China.
Just since 2009, China's total debt has tripled, from $10 trillion to $30 trillion, with the most growth occurring in corporate obligations.
The music hasn't stopped yet. In the first quarter of this year, borrowing in China reached a new high, growing 50% faster than last year. Total debt in China's economy is now 250% of GDP – a level that makes China one of the most indebted countries in the world. China's economy is running out of steam, despite these huge additions to its debt burden. As it enters a recession, a lot of its debts are going to go bad, putting more and more pressure on banks and other creditors around the world.
One final point... Look at the banks that have large exposure to China, Brazil, Russia, and other places where economic growth is driven by exports. Deutsche Bank (DB), for example. Its stock is down more than 50% over the last year. Citigroup (C) is down 25%. HSBC (HSBC) is down 26%. Mitsubishi UFJ Financial Group (MTU), Japan's largest bank, is down 31% over the last year. Weren't the actions of the world's central banks supposed to drive more lending and thus more revenue and profits for these giant institutions?
What has gone wrong is plain to see for anyone willing to look. The world economy, not just America's, is drowning in debt. Central banks can inflate financial assets for a long time... perhaps even longer than I believe is possible. But as the real economy (industrial production and trade) parts ways with the financial markets, I know it's only a matter of time before the real economy wins.
It's the default rate that matters, not the VIX.
As money eventually flees stocks and bonds, it's going to flood into gold and other precious metals.
I can't share the details yet, but we've been busy the past two weeks working on new research for Stansberry Gold Investor subscribers.
Something interesting is happening in the precious metals market today. And when we've seen this occur in the past, a small sector of the precious metals market has absolutely soared – with gains as high as 1,206% and average gains of nearly 400%.
Stansberry Gold Investor subscribers are already up 39% across our recommended portfolio. But I believe the next leg of the precious metals bull market is just beginning. And Stansberry Gold Investor readers will make a fortune.
And this new opportunity we've found is so big, we're actually changing the name of the product.
We'll be in touch next Wednesday with the full details.
New 52-week highs (as of 7/21/16): Welltower (HCN), ETFS Physical Platinum Shares Fund (PPLT), and Vanguard REIT Fund (VNQ).
In today's mailbag: Subscriber Steve R. sends one of the best "Fire Porter" replies we've received... and Tom W. has a question about "common sense." What do you think? Let us know at feedback@stansberryresearch.com.
"I don't know whether to laugh, cry, or just shake my head in disgust when I see the readers who want to fire Porter. How about you grow up and take responsibility for your own decisions? If you expect to read one newsletter for all your investment advice and expect it to be correct all the time; you are not an investor – you are a gambler.
"If you are not learning from the information that Porter puts out, you better start paying attention. The information that Porter and the others provide will absolutely help you reduce risk and increase wealth. BUT YOU are responsible for your investment decisions. Develop your investment plan.
"Can't short stocks in your IRA? Buy in-the-money put options. Stock price higher than you want to pay? Sell naked puts. Too many great investments and not enough capital? Buy in-the-money calls. Bullish or bearish doesn't matter. Having the knowledge on what to do when you are bullish or bearish is what matters.
"As Porter says, 'there is no teaching, only learning.' Learn all you can about diversification, position sizing, World Dominators, global trends, and income investing. Then make your investment plan on what instruments you want to invest in. It is your choice – accept responsibility for it." – Paid-up subscriber Steve R.
"I read these Digest articles day in and day out; most make sense to me... So one has to wonder if common sense will ever make a comeback?" – Paid-up subscriber Tom W.
Porter comment: We wish we knew, Tom...
Regards,
Porter Stansberry
Baltimore, Maryland
July 22, 2016
Bedtime in Cleveland
You can turn out the lights again...
In modern American politics, presidential candidates are selected by primary and caucus voters during a campaign cycle that's almost four years long. By the time we get to the national party conventions, we're tired of the whole process and ready to go to sleep.
The GOP convention in Cleveland was supposed to be different. It was supposed to wake us up. We were promised a wild floor fight among deadlocked delegates and massive demonstrations in the streets outside.
You can go back to bed now. But I won't say, "Sweet dreams." Nothing that happened during the four-day Trump infomercial at Quicken Loans Arena changed my mind about what's likely to occur in November.
Hillary "Lock her up!" Clinton will have a lock on the Oval Office.
The Republicans were playing sandman before the convention even started, when Trump announced that his vice presidential running mate would be Mike...
Mike Tyson? That would have been exciting. Mike Meyers? Austin Powers, International Man of Mystery, could be useful in the election fight against "Mrs. Evil." Mike Huckabee? You're getting warmer.
No, it was Mike Pence. "Mike who?" ask all of you who live in the 49 states that aren't Indiana.
Hoosier Gov. Mike Pence is a tea-party social conservative. He will attract to the Trump ballot all of the tea-party social conservatives who were previously going to vote for Hillary. I believe there are three of them.
He will attract no one else.
Here's a quick rundown of the convention "action"...
Convention Day 1
"Make America Safe Again"
(Yes, but it might also be a good idea to "Make America Dangerous Again.")
The important thing that happened was a floor vote to pass the Republican Party platform. That platform contains a harebrained call to reinstate outdated Depression-era Glass-Steagall banking regulations preventing commercial banks from investment-bank activity.
Going back to the way banks were run when Bernie Sanders was a kid – great idea! It will make things so much simpler. All we'll have to do is watch Jimmy Stewart in It's a Wonderful Life and we'll understand everything about the banking industry.
The other thing that happened was Donald Trump made an entrance to introduce his wife Melania. I mean he made an entrance – with fog machines, Oscars ceremony lighting, and Queen's "We Are the Champions" blasting at sports-event volume.
Do we want a presidential administration combining the features of disco, Hollywood, and the NFL?
Personally, as a Patriots fan, with Tom Brady suspended for the first four games, I'm not so sure.
Convention Day 2
"Make America Work Again"
(Well, maybe. But if somebody would get interest rates and bond yields back up to normal, I wouldn't mind retiring.)
The big news – in fact, as far as I could tell from checking the media, the only news – was that Donald Trump's wife Melania, in her speech to the Republican National Convention on Day 1, parroted some things that Michelle Obama said in her speech to the Democratic National Convention in 2008.
What poor soul, fresh out of journalism school, down in the bowels of some news organization, is forced to check these things?
As if candidates' wives ever have anything to say at party conventions.
Here's a word-for-word comparison between one of the passages in question:
Mrs. Trump in 2016:
From a young age, my parents impressed on me the values that you work hard for what you want in life, that your word is your bond and you do what you say and keep your promise, that you treat people with respect.
Mrs. Obama in 2008:
Barack and I were raised with so many of the same values: that you work hard for what you want in life; that your word is your bond and you do what you say you're going to do; that you treat people with dignity and respect...
I'm sorry, but you can't plagiarize the content of another person's speech if that speech has no content.
If Melania had come out and said, "Just be cute to get what you want in life, fib your head off, and treat other people like dirt," that would have been news.
Convention Day 3
"Make America First Again"
(Not sure about this one. Smacks too much of the late-1930s "America First" pro-neutrality campaign that made us late for the show on Pearl Harbor Day.)
Ted Cruz refused to endorse Donald Trump. Cruz is like the wedding guest who jumps up when the minister says, "If any man can show just cause why they may not be lawfully joined together, let him now speak or forever hold his peace," and then mumbles something unintelligible.
I assume this was a bad thing to do. But time will tell. Let's see how the marriage between Trump and the GOP works out.
Meanwhile, the anti-Trump street demonstrations were half-assed. Literally, in the case of this arrest reported in the Chicago Tribune:
Police Chief Calvin Williams said a protester whose pants caught fire got defensive when a police officer tried to put out the blaze. The man assaulted the officer, and "things escalated from there," Williams said.
Convention Day 4
"Make America One Again"
(One what?)
The message of Trump's acceptance speech was that things are awful in this country, and we need a Great Man to fix them.
Some of us more old-fashioned conservatives were looking around to see who that might be. Rudy Giuliani, maybe? Rudy fixed a broke, broken, and dangerous New York City. He preached a fire-and-brimstone sermon on Convention Day 1.
But it turns out Trump was referring to himself. Well, if he's going to win on a Great Man platform, Trump better start acting great.
According to the latest opinion polls, 59.1% of Americans don't think Trump is so great. Of course Hillary's disapproval rates are high too – 55.9%. So Trump only has to be 3.2% great.
If I were Donald Trump... no, that's ridiculous. My dad didn't leave me a fortune. He left me some Craftsman tools in the basement. My name is on only one building, my house. And it's only printed on the mortgage. Plus if I had my own reality TV show, it would be called "Those Darn Kids" and the tagline would be, "You're grounded!"
Still... To achieve 3.2% greatness, all Trump really needs to do is get a few percentage points more specific about the "Make America Great Again" ideas that he has.
He's already done that with his proposal for lowering corporate tax rates and boosting economic growth by repatriating capital that U.S. companies have parked overseas.
He should do the same for trade policy. America is getting a raw deal in a few cases, but Trump needs to spell these out. An across-the-board diatribe against free trade worries those of us who care about the economy. The costs of free trade, such as lost jobs, are obvious. But the benefits of free trade – lower prices for consumer goods and more efficient use of capital – are easy to overlook. Trump needs to show that he can strike a balance between the two.
A vow to build a wall should be supplemented with a vow to tear down the U.S. Citizenship and Immigration Services and replace that agency with something that works quickly and effectively to sort positive from negative immigration. This would satisfy voters who fear illegal immigration and reassure legal immigrants, some of whom might turn into voters for Trump.
He'll need them. According to the nonpartisan Public Policy Polling organization, Trump has the support of only 13% of Hispanic voters. This group went 27% for Romney, and that wasn't enough or Romney would be the incumbent.
While he's at it, Trump should provide some specifics for women, too. He's getting only 36% support from them. Romney got 44%. And, again, it wasn't enough.
Trump did provide one generality for women – his daughter Ivanka. She gave an excellent and polished speech invoking women's rights.
Never mind that Ivanka's apolitical talking points could just as well have been presented at the Democratic National Convention. Maybe Trump should ditch Pence and put Ivanka on his ticket before Hillary grabs her for the Clinton VP slot.
My Main Takeaway From the GOP Convention
I found it thoroughly refreshing. I'm wide awake and raring to go. As well I should be – I just had a four-day nap.
Regards,
P.J. O'Rourke
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