This Market Frenzy Will Get Even Crazier Next Year

This market frenzy will get even crazier next year... One last buying binge before the current bull market ends... What we can expect with high-yield debt in 2020... A bursting bubble that will likely continue... 'The smoking gun behind every market whodunit'... The long, dark winter of value investing is over...

On Friday, we looked at five financial markets and asked how they might surprise investors in 2020...

We covered U.S. stocks, global sovereign bonds, European banks, gold, and gold stocks.

Today, we'll finish up with four more markets, plus one market trend that deserves your attention right now. Remember, as I said Friday, I'm not making predictions... I'm just trying to figure out where markets stand today, and what would surprise investors in 2020.

One market has been in a frenzy for a couple years and seems like it's poised to get even crazier in the next year or two...

I'm talking about the global private-equity market...

This market appears set to go on one last buying binge before the current bull market ends. I believe that will happen for two reasons...

First, investors have fallen head-over-heels in love with private equity. It has become a must-have asset class among the well-heeled and institutions. As hedge-fund manager and former Bain Capital employee Dan Rasmussen told me in a Stansberry Investor Hour podcast interview last week...

Private equity is the hottest, sexiest asset class. Everybody wants in. Everybody is increasing their allocation – 94% of institutional allocators believe private equity will outperform public markets.

Stakes in private-equity funds are bought and sold like stocks and bonds. They normally trade at modest discounts to net asset value.

But according to Triago, a company that facilitates private-equity trades, stakes in these funds aren't trading at discounts today. Stakes in the biggest private-equity firms' funds are selling at premiums of 5% or higher.

Not only are they trading at higher prices, they're more liquid... Sometimes you can get a quote in just a few minutes, according to Triago. Roughly $90 billion in private-equity stakes has traded so far this year, 10 times more than a decade ago.

In short, the market for private-equity stakes has whipped itself into a frenzy. And based on all the evidence, it looks set to continue heading into 2020.

Second, private-equity firms are sitting on more unspent cash than ever. As of June, they had more than $2.4 trillion in cash just waiting to be spent. With the leverage typical of most private-equity deals, it could easily translate to double that amount in buying power.

And of course, private-equity investors are all humans, too. Cash burns holes in their pockets, prompting them to overpay at the top... just like everybody else.

Valuations of private-equity deals are high and rising...

It has been normal for these firms to pay mid-single-digit multiples of enterprise value ("EV") to earnings before interest, taxes, depreciation, and amortization ("EBITDA"). (Remember, EV is market cap plus net debt, while EBITDA is a popular cash flow metric. EV/EBITDA is a standard valuation tool used for the private-equity space.)

Today, private-equity firms are paying 11 to 12 times EBITDA. And Rasmussen told me the valuations of private-equity deals are higher than public market valuations today.

With nearly $2.5 trillion in dry powder, it doesn't appear that this train will slow down or reverse direction in 2020... That would be a huge surprise.

My colleague and True Wealth editor Steve Sjuggerud has predicted a big "Melt Up" in U.S. stocks (which appears to have begun). It sure looks like private-equity firms are set to contribute to that effect by pouring literally trillions of dollars into the market through levered buyouts.

Private-equity firms and their target companies finance with high-yield debt, so let's think about that market next...

With equities continuing to hit new all-time highs, most investors are in "risk on" mode.

It's normal for that rising tide of optimism to spill over into the high-yield – or "junk" – bond market. When equity values rise, it provides a larger capital cushion for debt investors. They're more willing to buy riskier debt when they feel the cushion is ample and growing.

You can see optimism about high-yield debt in their spreads over similar-duration U.S. Treasury notes. The ICE Bank of America Merrill Lynch U.S. High Yield Master II Option-Adjusted Spread is one way of measuring high-yield spreads...

This spread shows us the difference in yield of mostly fixed-coupon, speculative-grade debt of one-year maturity and higher, compared with U.S. Treasurys of the same maturity. It was recently around 3.51%, meaning high-yield bonds yield about 3.5 percentage points more than U.S. Treasurys of comparable maturity.

The Federal Reserve Bank of St. Louis' data go back to 1996. The spread bottomed in 2007 at 2.46%... and peaked in 2008 at nearly 20%. Except for that all-time low and the ensuing huge spike up in the financial crisis, the range roughly moves between 4% and 10%.

That puts 3.51% squarely on the low side, meaning junk bonds are expensive today.

It would surprise the market for junk-bond spreads to spike... And since yields and prices move in inverse, that means it would surprise investors if junk-bond prices crashed.

But cracks could be appearing in the junk-bond market. Though private-equity firms still appear to be healthy today, other high-yield issuers aren't looking great...

Longtime readers know oil companies are big issuers of high-yield debt. The price of oil is around $60 per barrel today, and we're finding more oil all the time. There's no physical shortage of fossil fuels, despite your average poor fool's gesticulations to the contrary.

Credit-ratings agency Moody's Investor Services has been warning of a coming wave of junk-bond defaults for more than a year. (And my colleague Mike DiBiase has done the same in his excellent distressed-debt newsletter, Stansberry's Credit Opportunities.)

Over the past decade, the number of junk-rated nonfinancial companies has risen 58% to its highest level on record. Whenever the next era of financial stress arrives, Moody's believes the stage is set "for a particularly large wave of defaults."

Overall, though, junk-bond prices don't appear to be expecting that big wave of defaults... They're priced for something close to perfection. And of course, we don't call them "junk" for no reason... So perfection is not a realistic expectation at all for this market.

One market finally got "surprised" in 2019, and it's hard to see it going any differently in 2020...

In 2020, will the venture capital bubble keep bursting?

As I mentioned in last Monday's Digest, the venture-capital market became a dot-com-style bubble over the past couple of years. We now have more than $1 trillion in venture-capital assets under management, with more than 400 "unicorns" in the world – private, venture-capital-backed companies valued at $1 billion or more.

The bubble started deflating this year, with the failure of WeWork's initial public offering ("IPO"), and the poor performance of IPOs like ride-hailing companies Uber (UBER) and Lyft (LYFT).

Remember, the venture-capital market is where early stage companies get funded, with the eventual goal of making the venture-capital investors rich through a successful IPO.

With this bubble already bursting, the bigger surprise would be a resurgence of interest and big returns for venture-capital investors and those folks who buy at a company's IPO.

Once a bubble starts to burst, it's probably not going to stop until it wipes out tons of misallocated capital and scares investors away for many years. This is one case where the surprise scenario for 2020 seems like it's hardly worth entertaining...

For most investors, the upshot will be a lot fewer opportunities to throw money at IPOs on the belief they'll make big, quick gains and cash out.

I hate even thinking about this next topic, but it's hard to miss it...

When it comes to the Federal Reserve, the surprise would be if it did anything right...

I'm not a Fed watcher. Well, I'm not really a Fed watcher. It's impossible to read daily financial periodicals without having the Fed shoved in your face every day.

I wish I could remember who said, "The Fed is the smoking gun behind every market whodunit." In other words, everybody thinks the Fed is behind every tick up and down in the stock and bond markets.

But that's delusional...

For example, if the Fed has so much control over interest rates, why is the yield curve so flat – with the 30-year U.S. Treasury bond recently paying around 2.35%, a mere 78 basis points (0.79%) more than three-month U.S. Treasurys recently yielding around 1.57%.

You'd think if the Fed really controlled interest rates, it would favor a more normal yield curve in which the longer-term Treasurys would reward investors much more for putting their money at risk for 29 years and 9 months longer than the three-month Treasurys.

There's the illusion of control and there's real control. The Fed seems to possess the former, not the latter.

Still, the Fed and its army of 400 PhD economists all show up for work every day, believing they're responsible for keeping inflation low and preventing high unemployment in the U.S., largely by buying and selling securities in order to keep rates at a particular target level.

They believe they're doing God's work, protecting our way of life. But they're really more like a team of demented chefs who burn everything they cook... and burn the entire restaurant to the ground every now and then, too.

In this case, the surprise would be if the Fed really had as much control as so many seem to believe... and as the Fed itself represents. It would be a surprise if it kept the economy and financial markets humming along without interruption or crisis, more or less indefinitely.

That's tantamount to the Fed telling the truth about itself. And I'm not holding my breath for that particular surprise to happen any time soon... or ever!

We've already covered U.S. stocks. But we'll end with a development near and dear to my heart that I believe will make some investors very rich over the next several years...

The long, dark winter of value investing is over...

For the past decade, buying the smallest, cheapest stocks in the market simply didn't work as well as buying the largest, fastest-growing, and most expensive stocks in the market.

The Russell 1000 Growth Index is up just shy of 350% since the March 2009 stock market bottom. During the same period, the Russell 1000 Value Index has risen just 200%.

That's a huge difference.

Regular Digest readers will recall that I said a new "Golden Age of Value" started back in September. Here's a snippet of what I wrote back then...

A brand-new "Golden Age of Value" began on Monday, September 9.

As our friend Jason Goepfert reported at SentimenTrader.com, that day saw the biggest one-day shift in momentum since 2009 between the best-performing stocks year-to-date ("YTD") and worst performers. Simply put, the worst performers YTD performed best that day, and the best performers YTD performed worst.

Of course, the best performers YTD have been the best performers of the past decade. These are the big, fast-growing businesses that trade at high valuations. The worst ones are the opposite... slower growing and cyclical, with cheap valuations...

Now, I'm confident that value has taken the market's reins and will outperform growth stocks – even in a bear market...

Extreme Value chief research officer Mike Barrett and I are shifting our efforts toward the high art of picking real, traditional value stocks... the likes of which we haven't really been looking for over the past several years.

It's time to look for them again.

Others have noticed the shift, but I'm pounding the table harder...

Of course, I'll be surprised if I'm wrong about the Golden Age of Value. But we're not talking about me... We're talking about what would surprise the overall market.

As it turns out, growth stocks are back in charge today... From September 9 through Friday's close, the Russell 1000 Value Index was up 7.2%, while the Russell 1000 Growth Index was up 9%.

The Russell Value 1000 Index outperformed the Growth Index from October 9 to November 9... But otherwise, growth stocks still appear to be in charge.

I believe this is temporary... But more important than that, it's once again true that the outperformance of value stocks would come as a greater surprise to the overall market.

It's a surprise I'm betting on happening in 2020...

We've already added five new Golden Age of Value recommendations to the Extreme Value model portfolio. And we're not planning to stop... More are definitely on the way next year.

Please realize that three and half months isn't long enough to know if I'm right about the dawn of the new Golden Age of Value. If I'm right, this shift will take years to play out.

And since I'm bullish on value stocks, I'm happy to recommend buying these stocks before they start beating growth stocks more consistently. We can load up on value-stock bargains today... and expect them to beat growth stocks and the overall market for years to come.

Five years from now, investors will look back on moments like this and wish they had at least allocated some money to value funds in their 401(k) accounts... or been more aggressive and bought a lot more value plays like the ones we're adding in Extreme Value.

As I've said in the past two Digests, I don't like predictions...

But it's impossible to be an investor and not constantly think about how the future might play out. You'd be a little bit crazy if you didn't spend at least some time thinking about it.

The best way to think about the future is to get a decent grasp of where we stand today... then figure out what – if anything – you should do about it. That's what we've done in Friday's and today's Digests. I hope you find this exercise as useful and profitable as I do.

Tomorrow, we'll begin our traditional Digest holiday series...

Longtime readers know it's a way for us to revisit some of our best work from our most popular investment advisories over the past year. And as part of this series, we're offering special discounts on six of our high-quality publications. So you won't want to miss them.

Our regular Digest coverage will resume on Thursday, January 2, 2020.

New 52-week highs (as of 12/20/19): Alibaba (BABA), Becton Dickinson (BDX), Blackstone (BX), Blackstone Mortgage Trust (BXMT), CBRE Group (CBRE), WisdomTree Emerging Markets High Dividend Fund (DEM), iShares Select Dividend Fund (DVY), Electronic Arts (EA), Equinox Gold (EQX), Facebook (FB), Hannon Armstrong Sustainable Infrastructure Capital (HASI), Ingersoll Rand (IR), iShares Russell 2000 Fund (IWM), JD.com (JD), Johnson & Johnson (JNJ), Masco (MAS), Microsoft (MSFT), Nordic American Tankers (NAT), Nvidia (NVDA), Invesco High Yield Equity Dividend Achievers Fund (PEY), ProShares Ultra Technology Fund (ROM), ProShares Ultra S&P 500 Fund (SSO), Sysco (SYY), ProShares Ultra Semiconductors Fund (USD), ProShares Ultra Russell 2000 Fund (UWM), ProShares Ultra Financials Fund (UYG), and Vanguard S&P 500 Fund (VOO).

In today's mailbag, one subscriber sends his season's greetings, which reminds us... Happy holidays from everyone at Stansberry Research. As we close in on 2020, keep your comments and questions coming through e-mails to feedback@stansberryresearch.com.

I just want to say Merry Christmas to Doc, Porter, Steve, and all of the great people working to help us investors not only make money, but to learn about investing as well. A special thank you to Doc for his tireless efforts to safeguard our health, which is far more important than our wealth." – Paid-up subscriber Keith J.

Good investing and happy holidays,

Dan Ferris
Vancouver, Washington
December 23, 2019