How We Uncovered 'Our Most Lucrative Discovery Ever'
Editor's note: Porter has called it "our most lucrative discovery ever."
We're talking about the "Golden Triangle" – a way to identify doubles in waiting with near-perfect accuracy.
This weekend's Masters Series features an exclusive two-part interview with Bryan Beach and Mike DiBiase, the two Stansberry's Credit Opportunities senior analysts who first identified the Golden Triangle chart pattern.
In today's installment, they explain why they're beginning to recommend stocks in a bond newsletter... discuss how they first stumbled upon this trading strategy... and show readers how this group of stocks quickly and reliably led to 100% gain after 100% gain...
How We Uncovered 'Our Most Lucrative Discovery Ever'
An interview with Bryan Beach and Mike DiBiase, senior analysts, Stansberry's Credit Opportunities
Sam Latter: We just passed the two-year anniversary of the launch of Stansberry's Credit Opportunities. Since then, the SPDR Barclays High Yield Bond Fund (JNK), a popular "junk bond" fund, is up less than 5%. How has your portfolio performed over that time?
Bryan Beach: The bond market has done very well over the last two years. We launched Stansberry's Credit Opportunities anticipating a credit crisis. It didn't come, and it has actually been a horrible time to try and find bond outliers. As bond prices rise, it's hard to find values in bonds, which is what we were looking for.
But incredibly, our track record has still been really good, even though we launched it at the worst possible time. The annualized gains on all of our open and closed positions is 23% since we launched Stansberry's Credit Opportunities.
Sam: Almost every Stansberry Research reader has bought a stock at some point. But only a tiny percentage of our readership has actually bought a bond. Why do you think that is?
Mike DiBiase: I think the biggest thing is that it's difficult. You can't do it with one click of the mouse, like you can with stocks. It's a much different market. You have to pick up a phone in most cases and call your broker. In some cases, you have to wait a few days, maybe even a week before your order is filled.
I think that scares off a lot of investors. You have to know the bond's nine-digit CUSIP number. Sometimes we'll recommend a bond at a certain price, and maybe the market price isn't there yet, and people are used to having their orders filled right away. With bonds, sometimes you have to wait a little bit for the price to come back down. Sometimes you may not be able to get in at a price you like. That's an experience that most people aren't used to.
Overall, it's a much more difficult process. But it's ironic... Because most individual investors don't invest in bonds, and because it's difficult and less liquid than the stock market, this friction creates a lot of the opportunities that we have in the bond market. Those factors make it much easier to find what we call "outliers," or bonds trading much cheaper than they should be, based on their risk.
Bryan: The other thing is that because of those dynamics, you end up with a different type of investor who's interested in the bond market. Your typical bond buyer is managing a portfolio for an institution, like a pension fund or an insurance company.
They're smart, and they don't have an emotional attachment to the capital. They're willing to be patient. Those are traits you have to have to be a bond investor. Stock investors like to chase stories. They like to buy and sell quickly. The dynamics Mike just mentioned lead to a different set of investors attracted to the bond market.
Sam: Can you explain why JNK is a good benchmark to use to measure your performance?
Bryan: If you want exposure to high-yield bonds, the easiest way to do that is to log in to your brokerage account and buy JNK. As Mike just explained, buying bonds isn't easy. It takes patience. But the difference between the 5% annualized returns in JNK shares and the 23% annualized returns in Stansberry's Credit Opportunities proves that this extra effort is worth it. We've done almost five times better than a fund that holds a basket of nearly 1,000 high-yield bonds.
Mike: But the bonds we're recommending in Stansberry's Credit Opportunities come from the same universe that makes up the junk-bond fund. While JNK is buying a huge, broad group of those bonds, we're selectively picking the safest bonds with the highest yields. When these bonds temporarily sell off, we buy them. And when they return to a normal level – often close to par – we sell them and pocket the higher return. We're finding the best opportunities in the high-yield market. And it's because we've been so selective that we've seen much higher returns.
Sam: Here's a question that I know is on every Stansberry Research reader's mind... In the past, Porter has gone so far as to say that if investors bought bonds, they would never buy a stock again. But now, we're actually beginning to recommend stocks in our bond newsletter. What gives?
Bryan: That has been something we've been talking about a lot over the last several months. But if you've been reading Stansberry's Credit Opportunities, you'll know that we've recommended stocks before as part of our bond positions.
Most bonds are $1,000 investments. That's what they pay back in principal at maturity. So if a bond is trading for $800, if we also think the equity is cheap, we'll take the remaining $200 and buy a little bit of the stock to kind of "juice" our returns. We call these types of positions "synthetic convertible bonds."
So stocks have actually been a small part of the portfolio from the beginning. It's not completely a new concept for this letter, but the strategy we're going to talk about today is focused on the bond market, how the bond behaves, and how bond investors think about it. Ultimately, this strategy belongs in a bond newsletter because frankly, the whole strategy came up when we were researching bonds.
Mike: Exactly. We stumbled upon this strategy when we were researching bonds. I see it as a supplemental service, or a value-add service to the existing bond letter. We're still going to recommend bonds every month and as a supplement to that. But we're also going to analyze the "Golden Triangle" stock opportunities that are out there. And when we see good opportunities, we're going recommend them.
Sam: Back up for a second. You just said you stumbled on this strategy, almost by accident. Can you walk me through how you identified the Golden Triangle trading system?
Mike: Sure. As you know, finding quick doubles in the stock market is easier said than done. You can look for a company set to soar when consumers flock to its new product. Or you can try to find a biotech company about to achieve government approval. (Nobody is better at that than our colleague Dave Lashmet.) Or you can look for companies that are prime takeover candidates.
Those strategies can work well. But what we've found is that the best place to look for potential 100% returns is in the "scrap heap." I'm talking about companies whose share prices have gotten crushed and are ready to rebound. Of course, not every stock that falls will recover. But many do, and finding the ones that will is the hard part. And over the past year, our team has spent more than 1,000 hours trying to find the common traits that the companies that did bounce back shared. Ultimately, we weren't able to spot any reliable triggers.
Then it came to me when I wasn't even looking for it. In fact, at the time, I was researching a bond for the June issue of Stansberry's Credit Opportunities. The bond I was interested in was expensive. I loved the company. It produced huge cash flows. But the bond was trading close to par.
I took a look at the company's share price and noticed that it had fallen a lot – it had been cut in half over the course of about four months. I thought, "Wow, this is a stock I really would love to own. I wish I could recommend it."
But because the bond was so expensive, we couldn't recommend the synthetic convertible trade Bryan was just talking about. There just wasn't enough discount on the bond to justify it. I said, "This looks like a classic example of bond investors getting it right and stock investors missing the boat."
I wanted to show our readers proof of the old Wall Street adage about how bond investors are smarter than stock investors, but I couldn't find any studies or white papers. I called Bryan and said, "You've been studying the markets for a long time. What have you seen on this?" He hadn't seen anything about the topic, either. So we decided to conduct our own study.
It sounds like a big task, and it took a lot longer than I had expected, but I enlisted the help of some other analysts on our team. We crunched the numbers, and when we looked at the results, we were stunned. We quickly realized that by looking at the divergence between a company's stock price and its bond price, you could identify stocks that are extremely undervalued and have the potential to soar in the coming months.
Bryan: Exactly. We wanted to zero in on the companies that had a divergence between what the bond investors and stock investors thought about the companies' prospects. And we found hundreds of examples. We took our time to dig through all of the data, and we tried to figure out which group was proven correct after one or two years.
What we found was that the bond market was generally right, and the stock typically ended up bouncing back to where it came from. We now had empirical evidence proving bond investors really are smarter than stock investors.
This ends up being a neat way to pick stocks. If you can find the companies whose stocks and bonds diverge, the bond market has proven to be right more often. In Stansberry's Credit Opportunities, we're focusing on that group of stocks.
Mike: It's not just "neat." When we sent this research to Porter, he called it "our most lucrative discovery ever." He was impressed. He sent us back to do even more research and back testing. And everything we've done since then has supported our initial conclusion.
Sam: Let's talk about that a little bit. Stansberry Research readers are used to Porter making big, bold claims. But this was different. He was so excited about this idea that he insisted we drop everything and host a free event last Wednesday to show viewers how this strategy works.
How exactly did you go about back testing the data to see whether this was an anomaly or whether you had discovered something big? Walk me through that process.
Mike: First, we looked for all stocks that were at least cut in half – whose value fell 50% – from 2010 to 2014. We also wanted stocks that fell quickly, within 24 months, not ones that fell gradually over five or six years.
Then we narrowed the group down by eliminating companies that didn't issue bonds. Not every company issues bonds. That eliminated around 70% of the companies on the list, but we still had plenty of companies to study. After all, more than 300,000 corporate bonds trade each month.
From there, we looked at what the bond prices did as the share price fell. We divided that population into two groups: the ones where bond investors agreed, and the ones where bond investors disagreed. If the bond didn't fall significantly while the stock was plummeting, we said that the bond investors disagreed. If the bond did fall, we said bond investors agreed. Then we looked at what the stock prices did over the next two years. We wanted to have enough time for the story to play out and see what happened.
Sam: What happened when stock and bond investors agreed?
Mike: When a company's bond price fell alongside its stock price, bond investors say, "The equity markets are right. There's a real problem here." Among these instances, the average stock fell nearly 90%. The corresponding bonds fell an average of 56%. Those are huge selloffs. In those cases, about 60% of these companies eventually went bankrupt. When bond investors agree with stock investors, you had better steer clear.
Sam: And what happened when stock and bond investors disagreed?
Mike: What we found was remarkable.
In our back testing, two years after a stock bottomed, 94% of the time, they went on to show a gain... And 61% of those stocks went on to double. In other words, when bond investors disagreed with stock investors, the bond investors were almost always right. The stock came almost all the way back to where it was – its high before it collapsed. Of course, when a stock falls 50% and then recovers, the share price doubles. And that rebound almost always happened within two years.
Like I said, we studied these occurrences between 2010 and 2014. We followed the stock for the next two years... And what we found was that if you had bought every one of these stocks, you would have an average return of 131%.
Sam: It sounds like you guys have found something special here. What's the downside potential in these stocks? Are they still susceptible to wild swings in their share price, or are they relatively safe investments now that they've fallen? And is this the kind of strategy that you should invest your rent money in?
Bryan: No, this definitely isn't for the rent money. It's still a speculation, and all of these companies fell for one reason or another. They're facing serious headwinds. If they were market darlings, they wouldn't be down 50%, 60%, or 70%.
The point I'd like to make is that this is a very contrarian strategy. With that comes risk. It's worth noting that these stocks can stay down for four, five, six months... or they can go even lower. So you'll have to be patient to use this strategy. You might not buy at the exact bottom, or it might slosh around for a while. But our back testing suggests that eventually, almost all of these stocks will bounce higher.
Editor's note: The Golden Triangle appears just 0.3% of the time among publicly traded companies... And once it appears, it has near-perfect accuracy and leads to 100% winner after 100% winner. Skeptical about these claims? We don't blame you... But you owe it to yourself to watch this brand-new presentation to learn more about this incredibly powerful pattern. Watch it here.