2022 Will Be the Year the Markets Crash

I'm not going to sugarcoat it... 'The mother of all crashes'… The Fed is out of bullets... It's heads we lose, tails we lose… Meet the 'zombies'... 2022 will be the year the markets crash... How to prepare for the coming crisis...

It's a wonderful time of year…

Even with the spread of the new COVID-19 variant, the December holidays afford us the chance to gather with family and friends and to reflect on all the things that we are grateful for...

I (Mike DiBiase) wish everyone a restful and peaceful holiday season. I hope you enjoy the bright lights, decorations, sugarcoated treats, and adult beverages (if you are so inclined).

As 2021 winds down, I also wish you a prosperous 2022.

With that in mind, I'm writing this Digest to help make sure that happens... You see, I have an important warning about 2022. If you are prepared, you can actually make next year one of your best investment years yet.

So please sit down in a comfortable chair...

Our mantra here at Stansberry Research is to give you all of the information we'd want if our roles were reversed. And that's what I'm going to do today. I'm not going to sugarcoat anything...

I believe 2022 will be the year the markets crash...

I say "markets" because I am talking about the stock market and the much bigger corporate bond market.

I'm not the only one who thinks this.

Michael Burry was one of the few who saw the 2008 financial crisis coming... Through his hedge fund, he made a big bet against the market in 2007 by buying credit default swaps on mortgage bonds.

The trade earned Burry's investors $750 million, and he pocketed $100 million for himself. Michael Lewis wrote a book about him that was later adapted into the movie titled The Big Short.

Burry is a guy we should all be paying attention to.

He doesn't share his thoughts often. When he does these days, it's usually through Twitter.

Today, Burry is predicting that "the mother of all crashes" is coming. He says the market is dancing on a knife's edge and recently tweeted this about the markets...

More speculation than the 1920s. More overvaluation than the 1990s. More geopolitical and economic strife than the 1970s.

Burry is doing more than just tweeting... He's dumping most of his stocks.

In his hedge fund Scion Asset Management, he cut his portfolio from more than 20 stocks down to just six at the end of the third quarter.

Not all of my colleagues at Stansberry Research will agree with my prediction...

But that's OK. After all, none of us can see the future...

But I believe you should consider all of our points of view and make up your own mind.

With that said, it's hard to argue that both the U.S. stock market and bond market are not in bubbles today...

The stock market (as measured by the S&P 500 Index) is up more than 200% since before the last financial crisis in 2009... Until last week's sell-off, the stock market was hitting record highs on almost a weekly basis. It's now up roughly 40% from before the pandemic... including being up about 25% this year.

Meanwhile, corporate debt has nearly doubled to around $11.5 trillion from $6 billion before the last financial crisis. This is an almost unfathomable number...

The scariest part of this debt isn't its sheer size...

It's the poor quality of it...

Corporate debt, just like consumer debt, can be divided into two general groups.

With consumer debt, you have prime and subprime debt... Subprime borrowers have much lower credit ratings and much higher credit risk.

With corporate debt, you have investment-grade and non-investment grade (or "junk") debt.

Investment-grade borrowers are like prime borrowers. Junk borrowers are like subprime consumer borrowers.

If you split junk debt in half by their credit ratings, the lower half ‒ in other words, the worst of the worst ‒ makes up 35% of all junk-rated debt today. Leading up to the last financial crisis, that percentage was only around 15%.

It's even worse with investment-grade debt...

More than half (57%) of all investment-grade debt is in the lowest-rated tier (BBB-rated). This is the highest percentage of BBB-rated debt ever.

What that means is that this debt is one level away from being considered junk. And when debt gets downgraded to junk, prices generally fall hard... they crash.

Keep in mind, companies are earning these poor credit ratings with interest rates near record lows, so the cost of debt is not as great as in higher-interest-rate periods. Investment-grade companies are paying less than 2% on their debt... Most junk-rated companies are paying less than 5%.

Still, around one out of every four companies in the U.S. can barely pay the interest on their debt... so-called "zombies."

In short, corporate debt is at a record high, while credit quality is at a record low.

This is what a bubble looks like.

The bubble would have already popped last year if the Federal Reserve hadn't injected trillions of dollars of stimulus money into the financial system... including buying corporate bonds for the first time in its history.

The Fed essentially gave junk-rated companies a "get out of jail free" card. And they've used it to borrow record amounts over the past two years.

Even zombies have been surprised by how easy it has been to borrow. As David Bernstein, chief financial officer of cruise-ship operator Carnival (CCL), told the Wall Street Journal...

Somehow I managed to raise $6.5 billion... I was amazed.

The Fed's unprecedented actions just inflated the bubble even further. But like all bubbles, you can't keep inflating them forever.

Recognizing a bubble is one thing... Predicting when it's going to pop is much harder.

But I believe the bubbles will finally pop in 2022...

That's because the Fed is out of bullets...

In an April Digest earlier this year, I called inflation the biggest threat to the markets today.

Back then, inflation had risen to 1.6% and Fed Chair Jerome Powell called it "transitory."

I never bought that...

I explained why inflation was going to continue to rise and why it was likely to stay high – well above the Fed's 2% target.

The latest inflation reading for November was 6.8%, the highest in 40 years. Powell finally admitted that the Fed should retire the word.

He now says high inflation should continue into the middle of 2022.

I don't know about you, but I don't pay too much attention to what Powell says on the subject of inflation anymore... He's lost all credibility.

I believe inflation is headed even higher. High inflation is here to stay. The reason has nothing to do with supply bottlenecks of consumer goods, despite what everyone is saying.

All you have to do is look at the U.S. "M2" money supply. M2 money supply includes cash, checking and savings accounts, and money-market mutual funds.

The M2 money supply has skyrocketed since the start of the pandemic...

Since the end of 2019, the money supply has increased by $6 trillion... up nearly 40%. For context, the M2 money supply has increased on average by around 6% per year since 2000. Last year, it increased 26%... And through the first three quarters of this year, it's up another 9%.

When the supply of money increases by 40% in such a short span of time, prices are going to rise with it. It's simple supply and demand.

The recently passed $1 trillion infrastructure bill will only add to the pile of new money in the system.

That's why I think inflation is here to stay. Over the next few months, it will eventually settle down back below 5%. But it will stay much higher than the Fed's 2% target for the foreseeable future.

The Fed has two choices to fight inflation...

It can decrease the money supply or raise interest rates...

Either one will pop the credit bubble.

Don't expect the Fed to try to decrease the money supply anytime soon. The only way it can do this is by selling Treasurys – something it's currently not even discussing – or requiring banks to tighten credit.

Both options would result in higher interest rates and much tighter credit... more than enough to pop the credit bubble.

We already know the Fed is planning on fighting inflation by slowly raising interest rates... And I mean slowly. It is doing this in two ways...

It's doing it indirectly by reducing (or "tapering" in Fed-speak) its purchases of Treasurys. The central bank began tapering its purchases by $15 billion per month in November and will up that to $30 billion now. The Fed had been buying around $80 billion to $100 billion worth of Treasurys every month since the beginning of the pandemic... Its purchases accounted for around 60% to 80% of all Treasury purchases.

Without the Fed's artificial demand, Treasury prices will no doubt fall. And when Treasury prices fall, interest rates rise... including five-year, 10-year, and 30-year rates.

The Fed also raises interest rates directly by raising the one interest rate it controls ‒ the federal-funds rate. This is a short-term rate banks charge other banks to lend overnight.

The Fed recently said it will raise this rate three times next year... and three times in 2023. The planned rate hikes are small... only 1.5 percentage points by the end of 2023.

The Fed has to move slowly. It knows it can't raise rates too fast. If it does, it will turn a recovery into a recession.

But at that rate, it will take years for the Fed to raise rates enough to catch up with inflation.

You can see this by looking at "real" interest rates. After factoring in today's inflation, investors are earning negative 5.4% on 10-year Treasurys.

But persistently high inflation won't allow the Fed to go slow.

It's going to have to go even faster if it's serious about fighting inflation.

In other words, interest rates are about to soar...

Higher Treasury rates have a ripple effect across the entire economy. It causes other interest rates to also rise... everything from mortgage rates to corporate-bond interest rates.

As rates rise, hundreds of companies will go bankrupt as they try to refinance their debt coming due. Suddenly, credit will dry up... It will set off the biggest wave of bankruptcies we've ever seen and cause the credit market to collapse.

I'm not saying every zombie is going to go bankrupt. Some still have lots of cash... Others are fast-growing, and their profits are increasing.

But many will.

Below are 10 of the largest "zombie" companies likely to file for bankruptcy as interest rates rise. These are companies you don't want in your portfolio. They can't afford their debt today. And they will have trouble refinancing their debt as it comes due over the next few years...

You can see that many of these companies operate in the industries hit hardest by the pandemic... airlines, cruises, and movie theaters.

But even before the pandemic, these businesses had loads of debt. The pandemic just made it worse. I recommend avoiding these companies at all costs.

Higher interest rates will send the economy into a recession...

I know what you are thinking... If the economy starts to slip into a recession, the Fed could put on the brakes. It could slow its taper and start buying Treasurys again to keep interest rates down if the market panics.

That's true... And economist Nouriel Roubini agrees. Roubini is a professor at New York University's Stern School of Business. Like Michael Burry, he predicted the 2008 financial crisis. Roubini thinks the Fed will chicken out.

As he told Bloomberg...

They are going to postpone any finishing of tapering or raising rates.

But as I said earlier, the Fed is out of bullets. If it does chicken out, that means more stimulus... and higher inflation.

Consumers can only handle higher prices for so long.

Persistent inflation crushes poor and middle-class folks. For these families, food, clothing, and energy costs make up a much bigger portion of their budgets.

Many households are running up credit-card debt just to pay the bills. Consumer credit fell throughout most of 2020 as people used their stimulus payments to pay down debt. But consumer credit is on the rise again as bank accounts are dwindling.

Higher inflation leaves less to spend on discretionary purchases. It results in slower economic growth and higher debt across the entire economy.

As Michael Burry pointed out, America's "real" wages are one of the few things that seem like they are down this year.

The Fed's choice is simple... higher inflation or higher interest rates.

No matter what the Fed does, we're headed for a recession...

The Fed can't keep inflation in check without raising interest rates. But higher rates will trigger a recession.

And it can't keep interest rates from blowing up the economy without more stimulus. But that will lead to even higher inflation... which will also lead to a recession.

Neither option is good... It's heads we lose, tails we lose.

That's why I think the next recession will begin in 2022.

David Blanchflower, an economics professor at Dartmouth College, thinks we're already entering a new recession.

Blanchflower and fellow researcher Alex Bryson have studied past recessions. In a recently published paper, they pointed out that sharp drops in consumer expectations tend to predict these downturns.

Forecasters didn't see the 2008 recession coming... But Blanchflower and Bryson say they would have if they'd paid attention to falling consumer confidence.

Consumer confidence peaked this past spring and has fallen sharply since then.

Blanchflower and Bryson offer this warning in their paper...

They missed it last time, hopefully they won't miss it this time.

You should be prepared for a major sell-off in the stock and bond markets next year.

Here's how you prepare for the coming crisis...

First, raise lots of cash... That's what Michael Burry is doing.

Then, use one of the "secret" strategies of billionaires like Warren Buffett, John Paulson, Sam Zell, or Wilbur Ross.

When a crisis unfolds, they use a type of investment completely outside of stocks to make more money than you ever thought possible. It's a sophisticated strategy that most retail investors know nothing about.

I'm talking about investing in distressed corporate bonds.

That's what my colleague Bill McGilton and I recommend in our distressed-debt newsletter, Stansberry's Credit Opportunities.

Investing in bonds involves a little more work than investing in stocks, but it is well worth the extra effort... Bonds are much safer than stocks.

And when the market crashes, some bonds become even safer to own as their potential returns increase. That's why you can make much more with this strategy in a crisis. To show you what I mean, take a look at our newsletter's track record.

We've seen a few mini crises since starting the newsletter in late 2015...

We saw one in early 2016 and one in March of last year.

In a crisis, corporate bonds become cheap. You can measure how cheap they are by looking at the high-yield credit spread. It's the difference between the average yield of junk bonds and the yield of U.S. Treasury notes with a similar duration. The spread is normally stated in basis points (bps), with one percentage point equal to 100 bps.

Over time, corporate bonds have yielded on average around six percentage points more than Treasurys, or 600 bps.

When the spread widened in late 2015 and early 2016 (peaking at around 900 bps), we recommended five positions.

The average annualized return of those positions was 36%.

And at the onset of the pandemic in March 2020, the spread widened to nearly 1,100 bps. We recommended eight positions in March and April of 2020 that we closed with an average annualized return of 59%.

The chart below compares the average returns of our recommendations in various periods with the return you would have earned investing instead in the overall high-yield bond market ‒ as measured by the largest junk-bond exchange-traded fund, the iShares iBoxx $ High Yield Corporate Bond Fund (HYG).

As you can see, we've crushed the market using our strategy. And remember, these are returns from bond investments, which are typically much safer than stocks.

The higher the spread, the larger our profits.

Here's what's important... those two sell-offs will be nothing compared with what's coming when the credit bubble finally pops... And it's set to pop soon.

During the Great Recession, the high-yield spread peaked at around 2,200 bps... more than twice as high as what we saw in March 2020...

With that in mind, I'd encourage you to check out this presentation from one of our loyal subscribers. He's just like many of you reading this essay, except for one big difference...

Thanks in part to our bond-investing strategy, this subscriber retired at age 52...

I'll let you hear the rest of the story from him. And after that, you'll learn how you can claim instant access to Stansberry's Credit Opportunities at the best offer we've ever made.

Get started right now... The offer expires this week.

New 52-week highs (as of 12/22/21): AbbVie (ABBV), Cerner (CERN) Invitation Homes (INVH), IQVIA (IQV), Knowles (KN), Lynas Rare Earths (LYSDY), Palo Alto Networks (PANW), PerkinElmer (PKI), Seagate Technology (STX), and Constellation Brands (STZ).

In today's mailbag, more feedback from those of you who decided to take an early retirement amid the pandemic... As always, send your notes to feedback@stansberryresearch.com.

"Yes, I am one of them. After 19 years in residential treatment for children and 30 years as a school psychologist, I decided that June 2020 was the right time. My school district went remote in March 2020, and I was able to begin my 'second career,' managing my own portfolio full-time instead of when I had a few minutes. That resulted in five-figure profits for the first time ever in 2020 and 2021. Better doing that from home than being a greeter at Walmart." – Paid-up subscriber Michael S.

"Hi Corey, That statistic you cited about how 90% of the workforce that has left last month is 55 or older. Well, that's me! I decided to shut down one of my businesses that is dependent on employees after a 33-year run, so that I can spend more of my time running my other business that does not need any employees. It was getting too difficult to find reliable help, and I just decided that it wasn't worth the stress and anxiety. I believe that it is going to take several years for the labor market to recover from the lack of individuals willing to work." – Paid-up subscriber Robert P.

"I laughed out loud when I read this. It's as if Corey thinks CNN is capable of publishing something that is actually true." – Paid-up subscriber Ken A.

Corey McLaughlin comment: I had language in the first draft that said... "CNN, of all outlets..." to allude to what you're talking about, Ken...

Even a blind squirrel finds a nut sometimes. They actually quoted someone, the labor economist, who had some useful information.

"I lost my job due to COVID cutbacks in 2020. Waited it out for three months, then put in for my retirement. It took me two years to find that job in 2017 after I lost my job in 2015. I did not want to go through that again. People just don't want to hire grey hairs in technology." – Paid-up subscriber Fred R.

"I took early retirement last October (I am 54 years old). My husband took early retirement this November (he is close to 56 years old). Our daughter has been working for four years after college.

"We achieved financial freedom and were thinking about retirement before the pandemic. Working remote was quite stressful, being isolated at home for one year was difficult. Even though software engineer's pay is great these days, we don't want to trade our life for more money.

"Hope the pandemic can be over next year so that we can travel internationally." – Stansberry Alliance member Wei H.

"Corey asked about the 'The Great Retirement'... I was 54 and had decided to retire early. Already had planned for it! It was pure coincidence! Still retired and earning income from trading options!" – Paid-up subscriber Stephen S.

Regards,

Mike DiBiase
Atlanta, Georgia
December 23, 2021