A special Digest...

A special Digest... How to 'hold cash'... The future of insurance stocks... What you should know about muni bonds and corporate debt...

Editor's note: As we mentioned yesterday, Porter's Tuesday Digest produced a huge number of new questions from subscribers.

The vast majority covered a few concerns in particular, including how to "hold cash" in IRAs or 401(k)s... what to do about insurance stocks... and the safety of muni bonds and investment-grade corporate debt.

To help clear up the confusion, today's Digest is a special "Q&A" from Porter, covering some of the most common questions we received...

Many readers asked about holding cash in retirement accounts, like IRAs or 401(k)s, that often have limited investment options. One example comes from subscriber Chris B., who asks...

Regarding your warning to raise and hold cash, you state that you wouldn't hold it in a money market fund. So where should I put cash that's tied up in an IRA or 401k where my options are limited? I'm not ready to cash out my retirement accounts just yet.

I (Porter) can't provide you with any personal advice because of regulatory and legal constraints. Also, as a simple practical matter, I don't know what choices your 401(k) provider offers.

I'd be surprised if there wasn't an option for U.S. Treasury bills. But if not, look for the shortest-duration U.S. Treasury fund option available, from the most reputable provider.

What you want to avoid, if you can, are money-market funds that attempt to offer slightly higher yields than Treasury bills. They generate those higher yields by investing in a range of corporate obligations, some of which are going to go bad over the next several months.

As long as you're holding U.S. Treasury bills or bonds, you'll be fine. After all, if there's a crisis bad enough to hurt 401(k) holders of U.S. Treasury bills, you'll need gold to hedge your risk in any case. That's why I have long recommended holding gold bullion as a hedge against the systemic risks to the dollar.

Regular readers know Porter believes insurance – specifically, property and casualty ("P&C") insurance – is the "best business in the world"... and the Stansberry's Investment Advisory team has recommended a number of these stocks.

Several folks – like subscriber John F. below –wondered if these companies could be hurt by bond market "contagion"...

I really appreciated your message [Tuesday]; especially about bonds. I have not invested in bonds at all. However, I did invest in the insurance stocks that are part of your portfolio and they have been the most steady performers through the recent volatility. However, I would think they may be heavily invested in bonds, and I wondered if we as investors should place tight stops on them or bail soon until the coming credit crisis plays out?

You're right, John. All of our insurance companies invest most (or all) of their "float" in bonds. For subscribers who don't know what float is, please see our earlier work on understanding insurance stocks.

As I explained, one of the biggest concerns during a debt default cycle is that credit risk is "contagious." It's hard (impossible, really) to know how it's going to spread. Our recommended insurance stocks will undoubtedly feel some pressure during this cycle.

It's certainly possible that one or two of them could suffer some major damage – but I doubt it. Why? These firms invest the vast majority (if not all) of their float in investment-grade bonds. While that doesn't mean they won't see some temporary losses, it does mean that they're not standing directly in the way of the freight train.

I suspect that most of the damage they'll suffer in their portfolios will be temporary. When the market panics and investors try to dump bonds hand over fist, there won't be enough liquidity to sell. Investors will be forced to sell whatever is trading. That'll probably be the higher-quality investment-grade bonds that these firms own.

But... they won't necessarily realize these losses, because insurance firms – unlike mutual funds or ETFs – don't provide daily liquidity to their policyholders.

Insurance companies are by far the safest kind of financial business to own because of their unique, almost "permanent" investment horizon... and because they don't have to worry about the cost of capital (assuming they're good underwriters).

So while it's likely that investors will worry about these stocks, and it's likely that they might even fall in the short term, I'll be surprised if we end up stopping out – especially considering that we're counting dividends against our trailing stop loss triggers. In short, if I didn't own these stocks yet, I'd look to buy these firms during the coming crisis... but I might not buy them right now.

Finally, a huge number of readers are worried about "collateral damage" to municipal bonds and other markets. From subscriber Paul E...

Porter, you have been presenting a compelling case for an impending collapse in the bond markets for a while. Well reasoned and compelling.

In anticipation of this crash unfolding, can you elaborate on the extensive collateral damage that will likely occur in other segments of the bond markets? Will muni bonds get dragged along? What about corporate debt in emerging markets, which seems to be a hot segment for some folks recently?

In the spirit of telling us what you would want to know if our positions were reversed, how do we better reconcile the almost polar opposite positions that exist within the Stansberry universe?

Great questions, Paul. Here's how you should think about the risks in the bond market right now – from most risky to least risky:

Now... I can already hear people arguing with me about this list. Don't bother. I know, there are high-quality obligations in almost all of these categories and there's junk in almost all of these categories, too. There are plenty of muni bonds I wouldn't want to own – like Puerto Rico's and Chicago's. There are plenty of "investment-grade" corporate bonds that I wouldn't touch right now, either.

Don't forget... at the end of the day, there's no such thing as a bad bond – there's only a bad price. I made a lot of money buying General Motors bonds in bankruptcy because I paid $0.15 on the dollar. And I would have made a lot more if the government hadn't given $30 billion worth of GM to the unions...

As a result, any kind of list or bond-market structure like this can only be given in general, broad terms. Worry about the stuff you own through mutual funds or other income "packages," because typically these managers will reach for yield and buy the lowest-quality stuff in the categories they're in... or, even worse, they'll buy a whole bunch of stuff they weren't ever supposed to hold. That's what happened to the Reserve Fund when it "broke the buck" during the last crisis.

My advice to build cash is based on my belief that we're in the early stages of a debt default cycle. During this cycle, lots of things are going to default (from the top down). I expect that around 30% or 40% of all currently outstanding U.S. high-yield debt will default over the next three years. That's roughly $3 trillion in debt.

I expect even more foreign corporate debt will default. The asset-backed securities are a lot harder to predict because there are different "tranches" of these obligations, and the securities include various credit protection schemes, such as over-collateralization.

One thing I'm certain we will see is a subprime auto asset-backed security default. I'm also sure there will be huge losses in student loans, where we estimate around 40% of the outstanding debt isn't currently being serviced.

Again, it's hard to know how exactly these problems will develop and how they will spread, but we're looking at trillions of dollars of debt, much of it highly rated, that's going to experience much-higher-than-expected rates of default.

In regards to the variety of investment outlooks you get from the folks who work for my company, I respect their opinions. When they're different than mine, I try to understand why. Where I think the facts are on their side, I (hopefully) change my mind before it's too late. None of us have a crystal ball. So I can't know that I'm right... or that they are. We're all doing our best to serve our readers.

Having said that, I'm pretty sure I'm the only analyst here who has focused this much on the issues inside the various bond markets. I've been working on these ideas since early 2013. My team has spent a ton of time on this work. We know more about aspects of the auto loan market, for example, than guys in GM's own financial group or the ratings agencies, because we've spoken with both groups about the issues in that market and they're behind the curve.

But more simply, there has never been a time in financial history where so much debt was created so quickly... and under such obviously weakened underwriting standards. The creation of so many obligations makes it impossible to avoid huge problems. That's the nature of debt and default. Eventually, I expect the other analysts at Stansberry Research will come around to my view.

And who knows? Their timing – and thus, their investment performance – might end up being far better than mine. Predicting the future, on schedule, is impossible.

New 52-week highs (as of 9/30/15): National Beverage (FIZZ).

We hope today's mailbag addressed your concerns. If you have a question on a topic that Porter didn't cover today, please send it to feedback@stansberryresearch.comfor us to answer in a future Digest.

Regards,

Porter Stansberry and Justin Brill
Baltimore, Maryland
October 1, 2015