The 25th anniversary of Black Monday...

The 25th anniversary of Black Monday... Another serious warning about bonds... Why it's time to speculate, not invest... A letter from a 20-something-year-old... What to do instead of going to college... 'I'll never be rich...'

Today marks the 25th anniversary of Black Monday, the day the stock market collapsed in a panic. As you'll see below... the market hasn't learned much since then. Nor will the market ever grow wise... as it is made up of humans who willingly forget their fears so that they may indulge their greed.

As always on Fridays... I've written the Digest personally. I've written what I'd want you to tell me if our roles were reversed. This week, I write you a warning: Not many of you will take me seriously. Some will argue the fine points and call me a fool. But some... maybe one or two kindred souls... will see the numbers I offer below and feel a slight chill in their bones. Another crash is brewing, my friends. They all start the same way, with a credit boom...

On October 9, 2007, the Dow Jones Industrial Average closed at 14,164. Almost five years later (October 5, 2012), the Dow stood at 13,610. In other words, the Dow is only about 4% below a new, all-time high mark.

Does it seem like our economy is really back to the booming days of the mortgage bubble? Maybe not.

But you'd never know we're in a recession by looking at the credit markets... Sources in the credit markets report the most aggressive pricing they've ever seen – as aggressive as the peak in 2006 and 2007. Prices on commercial mortgage-backed securities (CMBS), for example, are now well over par. That's up from trading around 50 cents on the dollar back in March 2009. CMBS issuance this year could top $40 billion, almost double the amount of new issuance the market expected.

It's the same story with issuance of other forms of asset-backed lending, such as credit cards and car loans. Total issuance of asset-backed lending in the third quarter was $48 billion. So far, year-to-date, total asset-backed issuance stands at over $150 billion, which is far ahead of the issuance for all of last year ($139 billion). Our sources say total issuance this year should almost reach $200 billion.

Support for the credit markets comes from institutions (banks, insurance companies, pension funds, etc.) searching for yield. As the Fed and the European Central Bank have intervened massively in the sovereign bond markets and the mortgage markets, they've driven yields on short-term debt down to almost zero. Institutions are then forced to reach further out on the interest-rate curve, in terms of both risk and duration.

This provides a massive stimulus to the credit markets. People who believe the central banks' effort to "prime the pump" isn't working – or who think the Fed can't create inflation – are incredibly naïve. Since 2008, financial debt outstanding has increased 41%. Industrial debt outstanding has increased 122%.

We decided to solve our dependence on credit and deficit spending... by creating record amounts of new credit and record annual deficits. Would anyone like to offer me odds that this approach will lead to a happy ending?

And... just as knowledgeable and experienced investors are beginning to worry about a new bubble in the credit markets, guess who has shown up to buy hand over fist? Oh no. Individual investor interest in corporate debt and securitized debt is reaching a new high. The public's willingness to buy debt seems to be just as correlated to high prices as the public's willingness to buy stocks. They always buy the top in both markets.

No, the public's interest in a frothy market isn't unusual... but it is extremely dangerous. The public – unlike pension funds, insurance companies, and banks – is likely to panic at the first sign of rising interest rates. Buying at the top, as folks are doing right now, sets the stage for a collapse later. The popular iShares U.S. Aggregate Bond Fund (AGG) has increased its shares outstanding 16%. The fund now has over $15 billion in net assets. It now yields far less than 4%.

Most worrisome, however, is the tremendous spike in high-yield issuance and prices and the collapse in yield. Today, the market recorded a new all-time low yield (6.2%) for non-investment-grade debt. (The market's yield is determined by the Merrill Lynch High Yield Master II index.)

As a result, the average price for a junk bond today is $1.04 on the dollar. Junk bonds are up 13.4% so far this year. Again, the public's involvement in these markets is soaring. The Barclays Capital High Yield Bond Fund (JNK) is now holding $12.5 billion in net assets... the iShares High Yield Corporate Bond Fund (HYG) is now holding $17 billion in net assets. My sources in the market expect total high-yield issuance to set a new all-time record this year, beating 2010's record of $264 billion.

Let me say this as plainly as I can: this is not a good time to be an investor. People who buy debt securities at these prices are unlikely to walk away unscathed. Either inflation or default will lead to far greater losses, on average, than the paltry interest offered today – especially for bonds with long durations or risky prospects. Likewise, as the credit being created today floods over into stocks, opportunities there will be diminished.

The irony is... these conditions are very likely to last for some time. Prices on credit will continue to rise. Spreads and yields will continue to contract. We're entering a manic phase of this bull market in debt. I don't know how long it will last... but at least another year (and maybe three) seems like a reasonable guess. It will take time for this enormous new excess amount of credit to roll over into the real economy and into the stock market. It will take time before this massive inflation of credit turns into a massive inflation of money. And in the interim, I expect the stock market to go up... way up.

If I believe we're entering a new, even steeper up cycle in the markets, why would I tell you that now is not a good time to be an investor?

I define investing as permanently delaying the consumption of capital. You do not want to buy low-yielding assets or companies at a high multiple of earnings right now if you plan to hold on to those assets for the long term. At some point in the relatively near term, there will be a crash in the credit markets (like there was in 2002 and in 2008). Those are the points in time when you want to put your capital to work on a permanent basis. Right now, all you have left is speculation. It's time to look for aggressive, leveraged, fast-moving opportunities. You need deals you can get in and out of in six- to 12-month time frames.

If you don't see great short-term opportunities, don't worry about it. Just start building your cash reserves. Understand... I think we're still a long way from the top... but we're now far enough away from the bottom that it's time to start thinking about risk. It's time to focus on return OF assets instead of return ON assets. Never forget Buffett's old saying: "I try to be cautious when I see others being greedy, and I try to be greedy when I see others being cautious." Nobody in the credit markets is being cautious anymore. And the credit markets rule the world.

New 52-week highs (as of 10/18/12): Advent Claymore (AVK), Berkshire Hathaway (BRK-B), iShares DJ U.S. Insurance Fund (IAK), iShares DJ U.S. Home Construction Fund (ITB), Longleaf Partners (LLPFX), W.R. Berkley (WRB), Johnson & Johnson (JNJ), Eli Lilly (LLY), Chubb (CB), Loews (L), Travelers (TRV), Alleghany (Y), ExxonMobil (XOM), and Encana (ECA).

In the mailbag today... Two letters to parents. The first is simple... it's what to do if you're 18 years old and don't want to go to college. Most Americans have forgotten that sooner or later, you have to get a job. As you'll see, I share my advice on how to get started with your career...

The second letter is much longer... but I'd encourage you to read it, and if you agree with me, to send it to your 20-something children or grandchildren. I responded to a 20-something son of a subscriber... The kid said yours truly has a low character and doesn't know what he's talking about. I'd like to hear what you think of my response. Let me know here: feedback@stansberryresearch.com.

"I have to say I agree completely with your stance on higher education. I find it ridiculous, especially in the current state of the economy, that students are encouraged to steep themselves in insurmountable debt to gain an education that will do them very little good in the real world. However, as the mother of an 18-year old son who will be graduating High School this May, what advice do you have for him after graduation? So far I have given him your advice to stay out of debt and invest between 10 – 20% of his paychecks in the stocks of world dominating companies. Is there anything else he should be doing or alternative avenues he should be researching with regard to a future career? – Paid up subscriber Kirsten Parker

Porter comment: Just to reiterate... My view on college is that it's not going to help most people achieve their financial goals. For most people, it's simply not worth the cost – especially the opportunity cost. On the other hand, for people who want to be a professional, college is essential.

A professional, by the way, is someone who works by the hour, but charges a lot. Fundamentally, a professional is no different than a plumber. Very few people – plumbers or doctors – will ever build any real wealth working by the hour. That's not meant to discourage anyone who wants to be a doctor. It's meant to draw your attention to the fact that professionals aren't nearly as wealthy, on average, as most people seem to believe.

Finally, I know many people value learning in a group setting and the campus experience more than they value money – especially if it's their parents' money. For them, college is perfect. Enjoy it, if that's your passion. Just don't borrow money to pay for it, because a liberal arts education at most colleges will never pay for itself in increased prestige or income. That's just a fact.

What should kids who don't want to go to college do to start their careers? Easy: They just need to get a job. And how do you get a job? That's easy, too, for any reasonably bright, dedicated, hardworking kid.

Tell your son to write down the things he'd most like to do, as far as he knows right now. Then get online and find several local businesses in those fields. Focus on small businesses that are going to be more entrepreneurial and have less formal hiring policies. (Avoid Human Resources, in other words.) Help him get an internship with one (or more) of these companies.

And how does he get an internship? He shows up. Looks the part. Introduces himself. Explains his desire to work in the field. Explains that he's happy to work for free. Proves he has useful skills, that he's an eager worker... and that he'll do almost anything to get an opportunity.

If he has to start by sweeping the floors, he should get into the office at 6 a.m. and have them swept by 9 a.m. Then he should try and learn something more valuable. After a few months, if he's got any talent at all, he'll land a paying job.

"I sent your recent piece entitled Two Simple Money Rules All '20-Somethings' Should Know to my two sons aged 27 and 29. The response from my older son is below. I thought you might be interested in seeing what he had to say... I would be interested in your remarks.

"Dad,

"I've done nothing but live beneath my means for years. I hardly buy anything, I hardly go anywhere, and I hardly spend any more money than I have to. It's not what most people would call "enjoyable" and most people couldn't live the way I live because they'd either be depressed or kill themselves from boredom. Luckily I'm not wired that way. Most of the extra income I make goes into my savings account. The rest? Bills, living expenses, and, personal entertainment, which isn't much when compared to most people my age. I've been doing this for three years and I couldn't buy a decent car straight off the lot if I wanted, let alone a small house. And by car, I mean something that's $25,000. Living expenses alone are ridiculous unless you want to live like a bum ... and that's only going to get you killed by some crazy crack fiend with gold capped teeth, no education, no morality, and nothing to lose, and who randomly decides to mug you one night while you're busy carting your overpriced groceries into the danger zone house you decided to occupy in hopes of saving a few extra shillings a year.

"So you have to live somewhat moderately, especially if you want to entertain any half-way decent girl(s) and/or experience any acceptable level of self-confidence. And living somewhat moderately equates to the following per month: $400-500 rent (with a roommate); $80-100 cable bill (TV+Internet); $50-90 phone bill (you can downgrade from a smartphone if you really want for a bill under $50); $100 for Health Insurance; $80 electric bill; $100-200 in groceries (and this factors in not eating much but also eating healthy, since eating healthy is generally a little more expensive than not); $120 for monthly lunch expenses at work (this can vary, but that's assuming you shell out $30 a week which isn't much considering lunch at a healthy place can run you $8-10 a meal); $200 in gas a month (and that's with VERY LITTLE driving like myself) ... and I believe that covers regular monthly bills for living like a normal person in 2012.

"This doesn't cover yearly bills or anything extra you have to buy. Car insurance equals to $320 a year for a fully paid off, aged, and hardly working 1998 car which makes you feel poor enough while driving around, and a flawless driving record. Then we get into clothes, car inspection fees, extra spending, books, occasional video game, or other forms of entertainment, special occasions, dates, drinks with buddies after work, etc. etc. etc. and so forth which easily equates to a few thousand dollars, if not more, in a year – easily – and that's assuming you are a semi-frugal creature such as myself. Oh! I forgot (added this after I was re-reading): $250 a month for a ridiculous student loan that arguably helped me land my first job.

"In total, you're looking at expenses roughly along the lines of $20,000 for monthly/annual living expenses that you can't avoid. Sure, you can work at reducing them here and there, but more than likely at the price of your own self-esteem. Even so, let's say that you did reduce the expenses; are the savings any more than $1000-2000 a year? $18k as opposed to $20k a year? No. Not in this scenario. You're better off spending the extra $2000 for a better life at present.

"Add to your $20k about 4-5k in other expenses for a year (which is a very, very low figure) and you come out to $25k. Now, on a salary of $45k you factor out around $3,786.00 in tax, although I'd get a refund of around $1000. So in total, let's say I net around $13,000 – $14,000 in actual unspent and bankable income. That's not a lot.

"You really have to make at least $80k a year and live the entirely same way to really start making any notable savings in a 10 year time period, or at least that's the way I see it. And that's with no wife or kids. If you factor in either of those, or, regrettably both at the same time ... well then, I say, "Good luck to you."

"You really have to be some form of specialist (doctor, engineer, programmer, handed down business) or some lucky kid that knew what they were going to do and had it all figured out when they were in high school if you aim to start running straight out the gate. Otherwise you are just another average Joe that has to climb the economic ladder, like me.

"I started at $35k and jumped to $45k within two years. I could probably find another job for $55-60 at present and figure that in another 3 years I could find a $70-80k a year job (if not more, depending on my experience). That might be a little ambitious, but it is doable. So, say I got to $80k salary at 33 years of age ... well hopefully by then I'd have close to $100k in the bank, which is nothing these days. Now, after that who knows what happens. Maybe you meet some people and create a business or you do well in a company and shift career paths ... but I'm just speaking on having a steady goal in place. The rest of my 30's would be devoted to learning as much as I could so that by the time I'm in my 40's I'd easily be making six digits a year. Once there, you can really begin to invest money (albeit not stupid ones), and look into real forms of lifetime prosperity. Right now, it's near impossible without draining all your money.

"I understand what the guy in that article is saying, and there is some truth to it, but if 50 people did exactly what he said, I'd guess that only a few (three or so) would be millionaires by the time they were 40. And from what I got out of that guy, he said that college degrees are worthless and that he had a former sales job – so that says a lot about the integrity of his character, there. He is a salesman, and guys with that type of mentality will sell anyone down the river to make a buck and aren't ashamed at their own lack of integrity or self-image to obtain what they want. College degrees really aren't worthless. Anyone in the business world can attest to that. They prove that people can accomplish things that people without them cannot – for whatever reasons. They also help educate people in more ways than they realize until later in life. I think they cost too much, but like I said above, everything costs too much now a days.

"I do agree with the man in not borrowing money. Aside from my computer loan, I haven't ever borrowed any other money and never plan on it. I have a credit card but I keep it paid off and generally only use it for gas to earn points which eventually turn into gift cards for Panera that in turn save me money!

"But no way living the way I live, even with a few investments here and there over the next few years, will I have a million dollars, let alone many millions, by the time I'm 40 unless I get lucky or something really shakes up the waters. And this is assuming I stayed single and had no kid(s). I could be wrong – and I'd definitely like to be! – but I'm looking at it realistically.

"And that's living the way I live, which is very abnormal for most people in the world today, but at the same time living well enough to retain some pride. I know from the past few years that the better you feel, the better you do. And I have to live well to feel better. So the way I look at it, the better I live the better I'll do, and as I begin to live better I'll continue to do better. As I said, success breeds self-confidence and self-confidence breeds success." – Paid up subscriber [Name withheld] Lakeland, Florida

Porter comment: Your son's opinions and beliefs about money, income, and saving are perfectly normal and are shared by most of the young people I meet today. I don't mean that in any pejorative way. Our education system is designed to produce employees... not leaders, not entrepreneurs... and certainly not millionaires. Most people believe what they do about money, commerce, income, saving, etc. because that's what they've been taught. As a result, they ignore their own experiences... sometimes for many years. That's a shame.

You'll recall that my advice for 20-year-olds was to work on increasing their incomes, staying out of debt, and saving as much as possible. This is far more important than trying to achieve any particular investment result.

If you borrow $100,000 to go to college, it is very, very unlikely you will be able to earn enough income and save enough money to repay the loan and end up with a million-dollar net worth by the time you are 40. But very few people can avoid the siren song of debt. That's why I always encourage people to look at the total costs of things – interest included – before they buy. (That's especially true of college. Don't forget the opportunity cost.)

I found it interesting that your son argues that a college degree is worthwhile... saying he'll understand the things he learned there later in his life. Meanwhile, he notes that he's still paying $250 a month for the privilege of attending. He says only that his degree might have helped him get his first job. Assuming he's been paying back his loan since he graduated at 22... he's now paid about $20,000 against his college debts. I'd wager that's far more than he has saved so far.

His experience is the same as almost all college graduates: they find their degree isn't worth much and it's certainly not worth what they paid for it.

According to the Library of Economics and Liberty, on average, folks who go to college (but don't finish) make $743 per week (around $38,000 per year). Folks who finish earn $1,043 per week (around $54,000 per year). Thus... even if you assign all of the difference in income to the degree (instead of to the differences in IQ and other abilities)... a college degree adds up to a whopping income difference of just over $1,000 per month. In other words, your son's college degree is probably worth about what I pay my yard man each year.

So... what will I tell my children about becoming independently wealthy by the time they're 40?

I will tell them that there are many more important things in life – like learning for the sake of broadening your mind, traveling, making friends, falling in love, and having children. You don't need to be rich to live a good, full life. But if they seem to be more interested in money than anything else, I will tell them to do two things...

First, I will tell them to work – hard, and for as long as possible. Second, I will tell them to save and save and save...

Consider this. Let's say you begin working hard at age 15. That's when I got my first hard, regular job. I was the kennel boy at the local vet. I got up before school and hosed out dog crap every morning from 5 a.m. to 7 a.m. I repeated the routine every evening. I also mowed lawns and did other odd jobs as often as I could get them.

Let's say you started working like this when you were 15. When you start out, you're making almost nothing – $9.50 an hour. Assuming you're able to work 40-hour weeks, you'll make $380 per week. Assuming you work 50 weeks a year, your gross take-home pay will be a paltry $19,000 a year. But that's OK... you're living at home. You can easily save half your gross pay. What about taxes? Well, like Obama says, you didn't build that. You gotta pay your taxes too, kid.

In our example, the kid would turn 16 years old with $9,500 in the bank. But because he worked his tail off and saved half his pay. True, that's a hardworking kid. I've seen it done. It's not impossible. Now, let's assume he piles the money into a diversified portfolio of short-term, investment-grade corporate bonds. Nothing fancy. He earns 5% a year after taxes. Let's also assume our kid is a hustler. By looking for and taking better jobs and earning bonuses, he's able to grow his income by 10% a year. That's not very hard for good workers – especially when they're starting out at $9.50 per hour.

If our kid keeps this up through when most of his peers have finished college, he'll have saved $157,000 by the time he turns 25. This approach doesn't require any special skills or degrees. It doesn't require any kind of miracle – other than hard work, discipline, and perseverance. Yes, those traits are very unusual, but they can all be learned. They don't require a gifted IQ.

He simply has to do a good job. He has to learn skills that are valuable to businesses and other people. He has to be utterly reliable.

At some point... maybe 15 years after he starts working, he'll need to start a side business to continue growing his income every year. That will require a bit more work. But it's not impossible. That's when his gross pay finally breaks well past average for a valuable employee (over $70,000 per year). But keep in mind... there's no windfall payday for our kid. He just keeps plodding along... earning a little bit more every year and faithfully saving like a squirrel in October.

Just doing this... starting at just over minimum wage, working hard, saving, and growing income at a reasonable pace... will make you rich. By the time our boy is 40, he'll have a nest egg worth $976,000. He'll have an income over $187,000 per year. He will be rich by any standard.

What variables really matter? Well, if you assume annual investment returns at 15% instead of 5%, his nest egg only goes up to $1 million at 40 – about $25,000 more net worth. Investment results make almost no difference to wealth building. (They make a huge difference to folks who are already wealthy.) What about saving? What if you drop our kid's savings rate back to a normal 15%? Even with a 15% annual investment return, the size of the nest egg collapses to only around $318,000.

Saving is the single biggest variable.

What about working? What if you assume our guy likes to take a lot of time off. Say he only works 40 weeks a year instead of 50. He goes to Europe or goes surfing... what happens then? Nest egg drops another $100,000 down to $254,000. In other words... even if our guy does well in his career... and does great with his investments... but he only saves like most people do... and he only works as hard as most people do... he'll end up like most people: without a pot to piss in.

On the other hand, if he can learn to save like most people never will and work harder than just about anyone else... he's almost certain to be very, very rich by the time he's 40.

By the way, your son has a very unfortunate characteristic that's common in the young people I meet today. He ties his feelings about his self-worth to his spending, instead of to his net worth (his saving). He's badly confused the near-term experiences of living rich with the long-term goals of being rich.

He says several times that he'll get depressed if he doesn't spend money. He says he has to spend enough to feel good: "living well enough to retain some pride..." He says he has to entertain girls, have an expensive cell phone and cable bill, and buy video games to have "any acceptable level of self-confidence." And he's even come up with a truly novel justification for the fact that he's not saving very much money: "The way I look at it, the better I live the better I'll do, and as I begin to live better I'll continue to do better. As I said, success breeds self-confidence and self-confidence breeds success."

I can only chuckle at this sentiment. What breeds success is smarts, dedication, and a sustained effort to improve. I've never seen a man earn a raise or a commission because he was living better. I've seen lots of people forgo enjoying themselves today to be better-prepared for work tomorrow.

Also, there's a very interesting link between your son's fatalistic view of his career (I'll never be rich) and his impression of sales and marketing. Nothing happens in business until someone makes a sale. As any real business person knows, the selling process is complex.

It's very hard to know what kinds of products or services will sell... it requires a lot of testing, development, and effort to be successful at any business. But one thing is certain: to get value in this world, you have to be prepared to give value... or else you won't be in business for long. Selling is mostly about making sure your customer gets what he needs and what he expects. Clearly, your son doesn't understand this idea, which makes me believe he doesn't really know the first thing about business at all.

That's the real reason your son is stuck... as he says, climbing the corporate ladder. He doesn't understand how to build a business... or even really how to save. As a result, he concludes: "No way living the way I live, even with a few investments here and there over the next few years, will I have a million dollars, let alone many millions, by the time I'm 40 unless I get lucky..."

He's right about that.

Regards,

Porter Stansberry

Baltimore, Maryland

October 19, 2012