New Signs of Trouble in Consumer Debt

More on the credit-market 'Groundhog Day'... New signs of trouble in consumer debt... Credit-card delinquencies are quietly soaring... This measure of financial stress is already back at 2008 levels...

Regular Digest readers know we've been tracking potential problems in the credit markets closely...

In short, over the past 10 years, the government, corporations, and consumers alike have loaded up on record amounts of debt they have virtually no chance of paying back.

U.S. federal debt has more than doubled from a little less than $9.5 trillion in the first quarter of 2008 to more than $21 trillion today. Corporate debt has soared from roughly $3 trillion to a record $6.1 trillion. And consumer debt – which actually fell for several years following the 2008-2009 financial crisis – has soared to a new all-time high of more than $13 trillion. That's more than $500 billion above pre-crisis levels.

Sooner or later, this credit 'boom' will turn to 'bust'...

There is no doubt a huge amount of this debt will go bad, and another crisis will likely follow.

Of course, what is far less certain is "when." It's incredibly difficult to predict the timing of these events. But we could be getting close...

For one, as we've discussed many times, the Federal Reserve is now raising rates and withdrawing stimulus for the first time since this boom began. The "tide" that helped drive this bubble is now going out.

And while the markets generally remain unconcerned about these problems for now, there are some signs of potential trouble beneath the surface. Porter covered a couple of these in Friday's Digest.

In particular, shares of several of the most-highly indebted companies like mobile telecom Sprint (S), rental-car agency Hertz (HTZ), and beauty-products maker Coty (COTY) have been crushed of late. And more important, the so-called "risk spread" now appears to be moving higher for the first time in years. As he explained...

Safe bonds, like U.S. Treasury securities, set a floor for interest rates. They're the safest bonds in the market, so they offer the least amount of yield for investors. You can measure how much risk is being priced into corporate bonds by comparing their yields with the government-bond yields. The difference is known as the "risk spread."

If I'm right and we're at the beginning of a big default cycle, we should see the risk spread growing as investors begin to demand more and more yield for the risk of holding corporate bonds instead of sovereign bonds.

Since early 2016, this measure of risk in the corporate bond market had been declining, from a spread of about 550 basis points (5.5%) to around 200 basis points (2%).

That is, holding a basket of high-yield corporate bonds was paying investors 2% more annually than holding U.S. Treasury securities with matching maturities... It is nuts to believe that a $20 annual premium is nearly enough compensation for the added risk of a high-yield bond compared with a U.S. Treasury.

The risk spread in the bond market has been growing since I wrote this warning last month. For the first time since January 2016, the spread seems to have broken an important technical barrier. It has "broken out" to a new high point on the chart. That could be an important signal of a trend change in corporate interest rates. The spread is currently greater than 250 basis points (2.5%). That's roughly a 25% increase off the lows.

But these potential warning signs aren't limited to corporate debt alone...

Like the "risk spread" above, most broad measures of consumer credit stress – like default rates on credit cards, mortgages, and student and autos loans – remain relatively low for now. But again, beneath the surface, there are reasons for concern.

For example, according to the data from the Federal Reserve, credit-card delinquencies at the 100 largest U.S. banks sit at 2.5% today. This is up from a low of roughly 2% in 2015, but again, it is well below levels that have warned of previous crises.

However, delinquencies at all other banks outside the top 100 have soared from less than 3% in 2015 to more than 6% today. This is actually higher than delinquencies at the same banks during the peak of the last crisis.

Likewise, Bloomberg data show credit-card charge-off rates at the top 100 banks has risen from less than 3% to 3.7% over the past three years. But at all other banks, charge-offs have nearly doubled from roughly 4% to 7.6% today.

What explains this discrepancy?

The answer is simple, according to new research from Bianco Research.

As this credit boom has gone on, the largest banks have ramped up rewards and other credit-card incentives to attract customers. As a result, other banks have loosened credit standards – issuing credit cards to less creditworthy customers – to compensate. And like the last crisis – when we saw trouble in the riskiest subprime mortgages first – these debts are simply "canaries in the coalmine" of the larger consumer credit markets.

Bianco also notes that the rise in these delinquencies coincides with another troubling sign.

Google search trends for several terms of consumer distress – including bankruptcy, default, payday loans, and food stamps – have soared over the past three years to levels not seen since 2008.

In short, a crisis may not begin this month, or even this year...

But make no mistake... It is coming.

Fortunately, it doesn't have to be a crisis for you.

As we've discussed many times, these problems will create outstanding opportunities for investors to profit. Until then, stay patient, protect your capital, and stick with us. As Porter put in on Friday...

You will be able to find bonds trading with 10% annual yields and total returns at maturity in excess of 15% annually. But... until then... I expect most high-yield bonds to be bad investments, on average. Likewise, you should strictly avoid owning any highly indebted stock, especially if it cannot currently afford its interest service.

I will continue to follow these trends and report on them as necessary in these Friday Digests. But for more details and more specific recommendations, please refer to the model portfolios and commentary in my subscription services, such as my Investment Advisory, which focuses on recommending stocks with extremely strong cash flows and balance sheets... Stansberry's Big Trade, which recommends put options on companies whose weak balance sheets we believe will lead them to bankruptcy... and Stansberry's Credit Opportunities, which follows the corporate bond market closely and recommends distressed credits we believe won't default.

New 52-week highs (as of 6/4/18): Apple (AAPL), AllianceBernstein (AB), Automatic Data Processing (ADP), Amazon (AMZN), Alibaba (BABA), Eagle Bulk Shipping (EGLE), Fidelity Medical Equipment Fund (FSMEX), ETFMG Prime Mobile Payments Fund (IPAY), Monsanto (MON), Microsoft (MSFT), Okta (OKTA), Ralph Lauren (RL), ProShares Ultra Technology Fund (ROM), Cambria Value and Momentum Fund (VAMO), Verisign (VRSN), and W.R. Berkley (WRB).

The feedback on the Friday Digest continues to roll in. As always, send your notes to feedback@stansberryresearch.com.

"What's up, Porter? Baltimore native here but living in TN now. Just wanted to encourage you by saying don't worry about the negative Nancies that give you a hard time. I would venture to say that the day you stop getting backlash feedback is the day you stop being as valuable to your loyal customers. I love the way you run your company, with a focus on education, quality research and (most importantly) calling it like it is!

"I feel like a Stansberry Research salesman. Not to pat myself on the back, but including myself, I have brought you 3 lifetime subscribers and am working on more. I'm only a good salesman when I strongly believe in the product. Selling your work is very easy! Wish you had a lifetime subscription referral program! Regardless, keep up the fantastic work and thank you for the integrity of your research. When you have 4 mouths to feed on a single income, researching great companies all day and understanding them is next to impossible. When it's time for the newest issue of True Wealth, it's one of the highlights of my month! – Erik F.

"As the owner of a one-year old black lab, Circe (the sorceress), I found your lab analogy hilarious. This our third one; Echo, (my wife says we have a Narcissis in the house), chocolate; Lola, vanilla, and now a black. Sex or color doesn't matter; they all gobble their food as though the Russians were in the next county as we used to say in the '50s.

"Love your Credit Opportunities and I'm waiting patiently for those solid 15% bonds to secure my old age, now in my ninth decade. Meanwhile, have done quite nicely on a number of the ones you've recommended to date. Faithful reader since the Pirate Investor days and charter Alliance member. The original price of $1,000 was and is the greatest bargain of my life." – Paid-up Stansberry Alliance member P.F.

"'No Such Thing as Teaching.' Porter, while I agree with the sentiment, please do NOT, EVER, put that sentiment into the third person. That would be enough to push the Snowflakes over the edge... Keep fighting the good fight, and if you ever abandon sarcasm to keep the peace, I'll stop reading. Okay, no I won't, but you get it." – Paid-up subscriber Terry G.

"'But... it's a bell curve. And there are outliers.' LOL." – Paid-up subscriber Neil S.

Porter comment: Glad you got the joke. There's hope.

Regards,

Justin Brill
Baltimore, Maryland
June 5, 2018