You've Been Hitting Juiced Balls... for the Last Decade

The spike in home runs... How the Fed 'juiced' stocks... 'The caribou factor'... Boeing's biggest quarterly loss... Good news and bad news... My high-handed mission...

If you've made several times your money in stocks over the last 10 years, congratulations...

But if you're still holding all the stocks that have made you those big returns, you might want to start getting cautious.

Why?

Because finance isn't baseball...

Let me explain...

In June 2018, Major League Baseball and a California-based private equity firm acquired baseball equipment maker Rawlings for $395 million...

The Missouri-based company, founded in 1887, makes the official MLB helmet and baseball used in major league games.

And the deal, according to MLB Executive Vice President of Strategy, Technology, and Innovation Chris Marinak, was made because the league was "particularly interested in providing even more input and direction on the production of the official ball of Major League Baseball."

Why?

Well, a month prior, the Washington Post reported that the MLB admitted what major league pitchers had long suspected: changes in the composition of Rawlings baseballs were responsible for the spike in home runs that occurred starting in the middle of the 2015 season.

An MLB report said the spike was due to the reduction of aerodynamic drag on the baseballs, but not "to a livelier, or 'juiced' ball."

You may remember there was talk of juiced or altered baseballs in the early 2000s, but an independent investigation known as the Mitchell Report fixed the blame on steroid use.

The players were juiced, not the baseballs...

The point is that now it's been discovered that the 'pill,' the core of the baseball, has been changed...

It used to be slightly off center, causing drag, making it harder to hit home runs...

Under MLB's strong influence, Rawlings now centers the pill, helping the ball fly straighter and a lot farther.

Players were silent about juiced balls until Houston Astros pitcher Justin Verlander spoke up last month.

The eight-time All-Star was picked to start for the American League in this year's All-Star Game for the second time in his career, and chose the occasion to sound off:

It's a f---ing joke. Major League Baseball's turning this game into a joke. They own Rawlings... If any other $40 billion company bought out a $400 million company and the product changed dramatically, it's not a guess as to what happened. We all know what happened. [MLB commissioner Rob] Manfred, the first time he came in, what'd he say? He said 'We want more offense.' All of a sudden he comes in, the balls are juiced? It's not a coincidence. We're not idiots.

Substitute the Federal Reserve for MLB and the stock market for Rawlings baseballs and you see where I'm going...

In baseball, they juice the ball and suddenly, the best pitchers are giving up more home runs. There's nothing they can do.

As of June 21, MLB was on pace to reach a new all-time high of 6,612 home runs –more than 500 over the previous record of 6,105, set in 2017.

I suspect MLB's credibility will eventually suffer, and it'll have to tell Rawlings to stop juicing baseballs. Or not. Maybe the fans won't care.

After all, in the markets, investors don't care that the level of interest rates has been "juiced" into negative territory by central banks all over the world...

Investors are enjoying the wealth effect (while it lasts... and it never lasts). They don't want to be bothered.

Credibility will suffer when the losses come in. If fans stop attending baseball games, MLB will have to act.

The thing is... I bet MLB won't say, "Hey fans, since you hate us juicing baseballs and we're starting to lose money, we've decided to juice the baseballs even more."

That, however, is exactly what you get with central banks when the losses in financial markets start piling up...

They say, "Since low rates and easy credit looked great until they killed you, we've decided even lower rates and easier credit are just what the doctor ordered."

They say this while knowing full well the "extreme brevity of financial memory" we mentioned in Monday's Digest will prevent fans – investors – from remembering how juiced rates eventually killed them last time.

It's like singer Harry Nilsson's old song about the lime and coconut...

A girl drinks a mixture of lime and coconut and gets a stomachache. So she calls the doctor, who tells her to do the same...

Put the lime in the coconut and call me in the morning...

Hair of the dog that bit you. I get it.

But this isn't some garden variety hangover we're talking about.

We could be looking at something worse than 2008, when Bear Stearns, Lehman Brothers, and Washington Mutual all "mistook leverage for genius," (as hedge fund manager Steve Eisman put it) and disappeared from existence.

Sooner or later, we should expect to get back to the condition it was alleged the Federal Reserve would cure...

Only now it will be exponentially worse.

Now, instead of the occasional banking "panics" that put a dozen or so small institutions out of business every few years in the late nineteenth and early twentieth centuries, we'll wind up with another 2008 crisis, maybe another Great Depression, or some equally ugly variant.

We have this hazy idea that maybe times are different, and we're sufficiently technologically advanced that no such thing can ever happen again.

But that's just something you hear people say at tops.

Do I even need to remind you who said, "Stock prices have reached what looks like a permanently high plateau. I do not believe that there will soon, if ever, be a fifty or sixty point break below present levels."?

(It was economist Irving Fisher in October 1929.)

I'm sure many readers will dismiss my hand-wringing as overwrought, or at least way too early...

Many will dismiss me as a frustrated bear, the financial equivalent of a Parisian pervert in the bushes... (A common complaint at the two-acre Bois de Vincennes nudist park in the "City of Lights").

Some bear I am... In the pages of Extreme Value, Mike Barrett and I have picked seven new long ideas this year, including three high-conviction ideas (great businesses where we don't use trailing stops, which Mike wrote about in yesterday's Digest).

Of course, I understand that bear markets don't happen often, generally pass very quickly, and are generally followed – eventually – by longer bull markets that see prices hitting new highs.

So maybe don't worry so much about the bear. But you still need to watch out for caribou...

From the late Leon Levy's excellent 2002 memoir, The Mind of Wall Street:

In the early 1970s, all the calculations for the cost of the Alaska pipeline were thrown out of whack when environmentalists sought injunctions to halt the project until the pipeline's effect on caribou could be studied and addressed.

It was thought that the pipeline as then designed would disrupt the migratory patterns of the caribou, which survive by eating lichens in one of the most inhospitable climates on earth.

Dealing with the caribou delayed the pipeline for about eight years, and since time is money, the changed timetable forced the pipeline's owner, Atlantic Richfield, to reprice the bonds that would finance the project... ever since then, investment professionals have referred to such unknowns as "the caribou factor."

Boeing (BA) is a decent example of 'the caribou factor' at work...

Boeing's 737 MAX aircraft definitely qualifies as the sort of big project that attracts "caribou," with airframe and engine program costs coming in somewhere between $3 and $5 billion.

Boeing started planning the new airplane in 2006. Ten years later, the first 737 Max took off from the Renton, Washington, municipal airport. Airlines started placing orders for the new model in 2011, and the plane quickly became Boeing's best-selling aircraft, with nearly 400 deliveries worldwide and more than 4,600 unfilled orders, according the New York Times.

Then, of course, two 737 MAXs crashed in October 2018 and March 2019, killing everyone aboard, for a total of 346 fatalities. By March 13, the 737 MAX was grounded worldwide, and the parking lot at Boeing Field in Seattle started filling up with undelivered planes.

The Department of Justice ("DOJ") continues to investigate (the flight control system is thought to be the cause), and recently expanded its inquiry to include Boeing's larger 787 Dreamliner.

Today, Boeing reported a $2.94 billion loss for the quarter ended June 30 – the biggest quarterly loss in its 103-year history...

With MAX shipments on hold, the company's sales came in 35% below last year's second quarter. The company took a $5.6 billion charge to cover the potential cost of compensating MAX customers, which may include discounts, services, and cash payments.

Boeing expects to get the 737 MAX back in the air later this year. Aerospace and defense stocks have done well this year, so Boeing has risen about 16% with them, but its stock is also about 16% off its March highs in the wake of the 737 groundings.

Investors might want to start asking if this is one of Warren Buffett's "great business with a one-time huge but solvable problem" situations...

What if the DOJ starts expanding its investigation beyond the 737 and 787?

The 787 shipments last quarter kept Boeing's loss from being even larger. A preemptive grounding of that plane would really create a serious caribou infestation for Boeing and its shareholders.

'Okay, Dan, juiced balls, juiced stocks, caribou... we get it. Do you ever report good news?'

Sure I do. We recommended Starbucks (SBUX) last August in Extreme Value. It's up about 76% since then. That's good news for folks who took our advice.

We're also pretty happy with our three gold-related picks, which have performed well along with the rise in gold prices.

But there's all kinds of good news in the world today, most of which is much better than any news about making money in stocks...

For example, scientists in Norway have released a paper which they say demonstrates that "anthropogenic climate change does not exist in practice," because there's not enough room for manmade influence in a good climate model, once all the appropriate natural causes of climate change are counted.

I'm no scientist, but if they're right, it's good news, since it means maybe we're not affecting our climate as much as numerous loud, angry voices say.

Even better news than that: global child mortality is down tenfold the last two centuries, according to Our World In Data, a group that monitors changes in global living conditions.

I know there are a lot of folks living in poverty today, but I'd also be willing to bet that more people today have a decent standard of living than ever before in our planet's history. If I'm right about that, it's certainly good news.

Believe it or not, I consider myself an optimist, despite the 'curmudgeon' label I seem to have earned...

I think most people who know me will tell you I'm a fairly upbeat guy.

So there's plenty of good news around, and I'm not blind to it. And there are plenty of opportunities for investors. Just ask any Stansberry Alliance member.

Unless my arithmetic is even worse than I think, Alliance members receive more than 100 Stansberry long ideas a year, mine among them.

That's not the work of a band of perma-bears and pessimists.

But let me ask you this...

If I'm right about how risky "juiced" stocks and bonds are today... and if the outcome is anywhere near what I think it'll be... and nobody told you about it – nobody pounded the table like a lunatic about it...

Would you be grateful for all the good news we reported before it all went south?

I'm not telling you to sell all your assets, buy guns, gold, and groceries and head for the hills...

I've never said that, and probably never will. I don't think that's the kind of world we live in, at least not in developed countries like the U.S.

I'll be the first to admit that, most of the time, you should totally ignore the overall, top-down state of the stock and bond markets.

It's just a waste of time, on average, most years.

But every decade or so, investors get a little too enthusiastic... central banks and various governmental agencies get a little too active in the economy... valuations soar and risks build up.

I'm trying to help you avoid what investor and author Howard Marks calls, "'a failure of the imagination' – the inability to understand in advance the full breadth of the range of outcomes."

That's what risk is: a wide range of outcomes.

For example, just compare bonds and stocks... The range of outcomes for stocks includes a lot more of them going to zero than it does for bonds, which have a narrower potential range of outcomes. Narrower range of outcomes, lower risk.

The range of outcomes for small-cap stocks is wider than it is for mega-cap stocks. Most mega-caps will survive. Many small-caps will not. Wider range of outcomes, higher risk.

When valuations get pushed up like they are today, and weird things like Mt. Everest-sized piles of BBB debt happen, it's time to fire up your imagination and appreciate the potential for any one of a rather wide range of outcomes to happen... and maybe sooner rather than later.

"Most of the time the future is indeed like the past, so extrapolation doesn't do any harm," Marks says, "but at the important turning points, when the future stops being like the past, extrapolation fails and large amounts of money are lost or not made."

If you're pushing age 60 like me, you want to avoid that whole 'large amounts of money' being lost thing...

And if you're like me, you'll spend all the time thinking about it that you believe necessary to accomplish the goal.

So you'll need to learn to protect yourself. I quoted John Kenneth Galbraith's essay, A Short History of Financial Euphoria, on Monday. I'll do so again today:

Regulation and more orthodox economic knowledge are not what protect the individual and the financial institution when euphoria returns, leading on as it does... to the eventual crash and its sullen and painful aftermath.

There is protection only in a clear perception of the characteristics common to these flights into what must conservatively be described as mass insanity. Only then is the investor warned and saved.

I'm not trying to be a downer. I'm trying to provide some "clear perception of the characteristics common to these flights" of mass insanity.

Forgive me if I sound high handed. But I'm on a high-handed mission.

I'm trying to save you from MLB, from the juiced balls of the Federal Reserve, and vast herds of caribou that want to delay your retirement by a decade... and reprice your entire portfolio faster than you'd ever believe.

New 52-week highs (as of 7/23/19): Blackstone (BX), New Oriental Education & Technology (EDU), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), iShares U.S. Aerospace and Defense Fund (ITA), Coca-Cola (KO), Medtronic (MDT), Microsoft (MSFT), and ProShares Ultra Technology Fund (ROM).

Do you have any questions or comments? We'd love to hear from you. As always, send your notes to feedback@stansberryresearch.com.

Good Investing,

Dan Ferris
Vancouver, Washington
July 24, 2019