Credit Risk Is Soaring Again
A great week for Stansberry's Investment Advisory subscribers... Credit risk is soaring again... High-yield spreads return to near-record lows... A new milestone for the European Central Bank... What the ECB could be targeting next... Corporate cash is plummeting... Don't miss this free training...
We wrote it... Did you buy it?
In the March issue of Stansberry's Investment Advisory, Porter and his team recommended a little-known way to profit from the ongoing bust in the energy sector: Ritchie Bros. Auctioneers (RBA). From that issue...
This month, our search for industries and businesses that will benefit from busted energy companies led us to the world of industrial equipment auction houses. After all, when a major company goes bust and liquidates, it often must auction off its equipment to the highest bidder. More bankruptcies equal more auctions.
As we began immersing ourselves in this business sector, one name kept popping up: Ritchie Bros. Auctioneers.
At the time, Ritchie Bros. was clearly out of favor. Shares were trading near an all-time-low valuation. But Porter and his team noted that the company met many of the criteria they look for in a great long-term investment, including: a capital-efficient business model, a rock-solid balance sheet, excellent management, and steady growth. They also highlighted its "formidable economic moat" (emphasis added)...
With any auction business, participation drives the value of your product. Buyers attract sellers, and vice versa. Both sellers and buyers know that an auction at any of Ritchie's 44 locations will draw plenty of participants... which is not something that a new entrant can replicate.
This is one of the reasons that Ritchie Bros. is five or six times larger than its closest competitor – an online-only auction site called IronPlanet. Certain manufacturers – like Caterpillar and Volvo – also compete with Ritchie Bros. by conducting their own auctions. But these competitors have not made a serious dent in Ritchie's business.
Despite Ritchie's dominant market position, it has significant opportunities to extend its reach. Every year, about $360 billion worth of used industrial equipment changes hands. Much of this commerce happens through private sales or broker relationships. Ritchie auctions only account for about 1% of this total market. That's a lot of room for growth.
Last week, Ritchie Bros. announced two big moves that should allow it to do just that. As news service Reuters reported...
Canadian industrial auctioneer Ritchie Bros. Auctioneers said it will buy IronPlanet, a privately held U.S. e-commerce site for used equipment, for about $758.5 million, as it looks to diversify its portfolio...
IronPlanet, backed by Caterpillar Inc., allows users to place bids online or on-site, or buy at a fixed price. It offers a multi-channel platform for the sale of assets. Ritchie Bros. also announced a deal to partner with Caterpillar for live onsite and online auctions of Caterpillar's used equipment. The deal will replace and expand on existing agreements between Caterpillar, its dealers, and IronPlanet.
In short, Ritchie Bros. just neutralized two of its closest competitors in one fell swoop, and further solidified its dominant market position.
Shares soared nearly 30% on the news, and are currently trading at a new eight-year high. Stansberry's Investment Advisory subscribers are up about 45% in a little more than six months.
Elsewhere in the market, high-yield credit quality continues to deteriorate...
In a report released Thursday, market-intelligence firm S&P Global Ratings said the number of "weakest link" companies – those at serious risk of default – jumped to a new post-crisis high of 251 last month. This is the most since October 2009, when the total was 264.
According to S&P, these companies – which hold both its lowest junk ratings and a negative credit outlook – are nearly 10 times more likely to default than ordinary high-yield issuers. And they currently account for an incredible $360 billion of outstanding debt.
It's worth noting that energy companies still lead the list, but they're no longer the only concern. S&P notes oil and gas companies account for just 25% of the weakest issuers today.
In the meantime, investors haven't let a little thing like worsening credit quality ruin their fun. Instead, they've been piling into junk bonds at the fastest rate in years, making it one of the most popular and best-performing sectors this year.
According to research firm FactSet, high-yield bonds – as represented by the iShares iBoxx High Yield Corporate Bond Fund (HYG) – have returned 12% year to date, compared with the S&P 500's 8% return.
But there are reasons to believe the party could be coming to an end. In particular, because junk-bond prices have soared so much, yields have plunged. (Remember bond prices and yields trade inversely... Yields fall when prices rise, and vice versa.) Today, the high-yield spread – the difference in yield between junk bonds and "risk free" U.S. Treasury debt – has fallen back to last year's near-record lows...
In other words, junk-bond investors are now being paid less to take on extra risk than any time since last summer... just before the market plunged and yields shot higher. As Kathleen Gaffney, manager of the Eaton Vance Multisector Income Fund, noted to the Wall Street Journal over the weekend...
When spreads get very tight as they are now, you're not getting paid as much for taking on credit risk. That means your bond becomes much more interest-rate sensitive.
Congratulations to the European Central Bank ("ECB") on reaching a mind-boggling "milestone" last week. As the Financial Times reported yesterday...
It's taken 18 months but the European Central Bank has... now purchased over 1 trillion euros in government bonds since it began its foray into quantitative easing back in March 2015...
In its latest set of weekly asset purchase numbers, the ECB revealed it has now snapped up 1,001 billion euros in sovereign debt in the week ending September 2, up from 990 billion euros to the end of the previous week.
Despite its late start, the ECB's balance sheet is now on pace to exceed the Federal Reserve's in less than 12 months.
The ECB is expected to announce a six-month extension of its quantitative easing ("QE") program at its next monthly policy meeting this Thursday. There's just one problem...
As regular Digest readers know, the ECB is quickly running out of bonds to buy. According to the latest figures from Credit Agricole, at the current rate it will own more than half of all eligible European government debt by the end of this year.
The ECB has already altered its QE rules to include some investment-grade corporate debt. Some analysts believe it could soon take a page from the Bank of Japan's playbook and start buying equities, too. As the Journal reported on Sunday...
A move by the ECB into equities would have big implications for Europe's stock markets, which have been rocked by a series of shocks this year, from volatility in China to Britain's vote to leave the European Union. The prospect of billions of euros flowing into equities could prop up prices, much as ECB bond purchases have done for debt securities. The signaling effect from the ECB's unlimited money-printing power may also limit downturns in equities...
"The obvious reason for the ECB to buy equities is they have almost run out of German bonds to buy," said Stefan Gerlach, chief economist at BSI Bank and a former deputy governor of Ireland's central bank. "The basic idea is that the central bank can put essentially anything on its balance sheet and there is no reason to be straight-laced about this."
What could possibly go wrong?
Here in the U.S., it appears the five consecutive quarters of declining corporate earnings are finally taking their toll...
Bloomberg reports the "once-towering piles of money at American companies have started to topple." Cash and cash equivalents for S&P 500 companies dropped to a median $860 million last quarter – a three-year low.
Worse, Bloomberg data show the 50 richest companies account for more than half that total. Removing those paints an even darker picture than the headline numbers suggest...
For the remaining 90% of S&P 500 companies, cash balances are falling at their fastest rate since the bull market began. Where's all that cash going? To buybacks and dividends, of course...
Most of the cash depletion represents compensation to shareholders at a time when coffers aren't being replenished as quickly. Total buybacks and dividends in the S&P 500 equal about 128% of annual earnings this year, the most on record outside the financial crisis, according to an August report by Barclays Capital.
So long as companies are able to keep borrowing at record-low yields, this trend could continue. But there are signs the tide may be turning...
New buyback announcements are down $115 billion since 2015, and dividend growth is on pace for the worst year since 2010. Meanwhile, data from ratings firm Standard & Poor's show that global corporate debt has already hit three times earnings before interest, taxes, depreciation, and amortization (EBITDA)... the highest level since 2003, and nearly three times higher than last year.
As we mentioned last week, this debt-driven cycle is unsustainable... If earnings keep falling – and again, they have declined for five consecutive quarters – it's only a matter of time before this trend grinds to a halt.
Finally, a quick reminder before we sign off tonight...
If you haven't had a chance to check out the free training video from our friend Dr. Richard Smith, founder and CEO of TradeStops, be sure to do so now.
Again, this special video was recorded exclusively for Richard's TradeStops Premium and Lifetime members. But he has graciously agreed to share it with all interested Stansberry Research readers for a limited time... absolutely free of charge and with no obligation. He has even made it easy to pause, rewind, and fast-forward the presentation, so you can easily take notes or take a break.
Unfortunately, time is almost up. This video will only be available until tomorrow. Click here to view it now.
New 52-week highs (as of 9/2/16): Berkshire Hathaway (BRK-B), Cisco (CSCO), WisdomTree SmallCap Dividend Fund (DES), Drew Industries (DW), iShares Core S&P Small-Cap Fund (IJR), Nuveen Preferred Securities Income Fund (JPS), KraneShares CSI China Internet Fund (KWEB), Paycom Software (PAYC), Sysco (SYY), Guggenheim China Real Estate Fund (TAO), and Invesco High Income Trust (VLT).
The gold and silver feedback continues to roll in. Let us know what's on your mind at feedback@stansberryresearch.com.
"In response to your request to know 'how [I'm] doing' and in response to the recent mailbag entry in which a subscriber complained that his portfolio of your precious metals selections was down 60%, I have to say that my experience is very different.
"Without doing a lot of math on the individual investments of which I have about a dozen, the account which has my precious metals holdings is almost entirely in precious metals/stocks. The account high was about $110K and it now sits at $98K. That's about an 11% drop, right in line with what you responded to the other reader.
"So, for me at least, everything is on track... If the correction makes prices even more attractive, I am looking to add more gold stocks since I've been concentrating much more on silver so far. Best regards." – Paid-up subscriber Greg H.
"My portfolio is around 40% weighted to metals as of Nov. of 2015. This little pullback is a BUYING OPPORTUNITY if you hadn't noticed. NOTHING with respect to the basic elements (i.e. debt, currency, asset bubbles, etc.) in the global economy – which have supported the rise of prices in metals – has changed for the positive. On the contrary! No need to panic, hold your water and carry on. We ain't nearly there yet." – Paid-up subscriber M.C.
"Just in case people panic and can't stomach the ride in gold and silver... All kinds of media types question these outrageous claims of $10,000 gold and $600 silver, but anyone can get more than an inkling of what is going on just by looking at the U.S. National Debt Clock website which is continuously updated... I am sure that you are well aware of this website but subscribers should be aware of the government's own calculations which shows dollar to gold ratio of $8100 and silver to dollar ratio of $896.
"Hmmm... The numbers Porter was talking about don't look so outlandish anymore do they? These are straight from the Government itself. What is even more unfathomable is the 500K every man, woman and child in this country owes based on assets per citizen and liabilities per taxpayer combined. Try to sleep well if you are not prepared for what is coming. Stocks can be bought, sold, whatever, but physical gold and silver I am buying high and low. I don't really care how I get it as long as I can get it while I can..." – Paid-up subscriber R.J.
Regards,
Justin Brill
Baltimore, Maryland
September 6, 2016
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