A Mind-Boggling New Record for Global Debt

Extreme Value subscribers are up 700% and counting... The buyback boom could be over... A mind-boggling new record for global debt... Dalio: Bonds are priced for disaster... The only way to make 10 to 20 times your money by 'shorting' debt...

New all-time highs for this 'World Dominator'...

We wrote it, did you buy it?

A little more than five years ago, Dan Ferris and Mike Barrett introduced a new World Dominator to the Extreme Value portfolio.

They recommended buying Constellation Brands (STZ) – the No. 1 U.S. premium wine producer and owner of the No. 1 U.S. beer importer, Crown Imports – up to $25 per share. As Dan explained...

I view Constellation as a "Wayne Gretzky" stock. Gretzky was arguably the greatest professional hockey player in history. He's famous for saying, "A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be."

Well, a good investor evaluates the present condition of a business and buys with a margin of safety. A great investor sees into the future better than others and buys today where the profits will be tomorrow.

Longtime Stansberry Research readers know that booze is often a wonderful business. As former Editor in Chief Brian Hunt often says, it's unlikely that having a beer after work will ever become obsolete. People will drink during both good times and bad.

Constellation had made some missteps and was relatively unloved at the time. The company had racked up substantial debt from a series of large acquisitions over the previous decade.

But Dan and Mike noticed that management had recently committed to turning the business around... It decided to sell less-profitable assets, pay down debt, and shift its focus from acquisition growth to growing the existing premium brands. As they wrote at the time...

In just a couple years, Constellation has transformed from a losing, leveraged roll-up facing a sharp recession, to the World Dominator of premium wines.

Despite the turnaround, shares were still incredibly cheap. They estimated the stock was trading at a discount of at least 33% to the value of its assets...

Constellation is currently trading at roughly seven times annual free cash flow. The business at this point is like a bond yielding about 13% today, and it could be yielding 15% over today's cost within a year. Constellation is worth at least 50% more than what it's trading for today... probably double.

That's exactly what I'm looking for in a World Dominator. A World Dominator under 15 times free cash flow is a bargain. Under 10 times is ridiculous. Constellation Brands isn't perfect, so the lower valuation makes a little sense. But seven times free cash flow? That's way too cheap for a great business like this.

Yesterday, the stock marched to a new all-time high after the company reported better-than-expected earnings for the second quarter. Sales and net income both rose 17% compared with the same period in 2015. The impressive performance also led the company to raise its 2017 fiscal-year outlook to $6.30-$6.45 a share, well above analyst expectations of $6.28.

Shares closed the day at $168.60. Extreme Value readers were up a remarkable 703% as of yesterday's close... making Constellation the highest-returning open recommendation across all Stansberry Research portfolios.

Constellation was a quintessential Extreme Value recommendation. And it's a great example of the simple power of buying a great business at a significant discount (or "margin of safety") to its underlying value. As Mike explained to subscribers on the five-year anniversary of the recommendation this June...

Buying tomorrow's profits with a margin of safety today is the essence of successful investing. The key is looking into the future and imagining how the story will change.

Back in 2011, we correctly anticipated that Constellation Brands' distinctive wine and beer assets would continue to generate growing amounts of cash flow.

We also correctly viewed the shares as undervalued in relation to this upside. Operating cash flow in fiscal 2011 was $620 million. Last month, STZ reported that results for fiscal 2016 ending February 29 had more than doubled to $1.4 billion. That equates to growth in operating cash flow of 18% per year over the past five years. Constellation's growth and profitability have exceeded the expectations we set in 2011.

Following yesterday's new all-time high, we asked Dan to sum up his thoughts on the news. Here's what he told us in a private e-mail...

I believe there are two primary reasons why this worked out as it did. One, Mike found an awesome business in distressed condition and kept after me until we recommended it.

And two, when the share price dropped 22% in five days after the Modelo deal fell through, we told subscribers to continue holding. Many people would have panicked and sold. But we were confident the investment case was intact.

That's really it... Finding a great business at a distressed valuation, knowing exactly how great it is, and refusing to sell it unless that changes.

Of course, finding a great business like Constellation trading at a discount is getting harder and harder these days. In fact, Dan notes that just 1.7% of all stocks trading on U.S. exchanges even clear their first Extreme Value "hurdle."

As he often says, the one thing that separates Extreme Value from most other advisories is that they're willing to say no. If nothing is good or cheap enough to recommend, they won't make a new recommendation that month... even if it upsets readers and costs them subscribers.

Unfortunately, this has meant that they have been unable to recommend new Extreme Value stocks several times this year. But that's about to change...

Dan and Mike are preparing a brand-new recommendation that meets their strict Extreme Value criteria. We can't share the details just yet, but Extreme Value subscribers will get the full story in the October issue, due out next Friday, October 14.

If you'd like to learn more about the Extreme Value approach to investing – including how you can be among the first to receive Dan and Mike's brand-new recommendation next week – click here.

One of the biggest drivers of the broad market may be fading...

Regular Digest readers know U.S. companies have been buying their own shares like there's no tomorrow. And this buyback spree has been one of the biggest tailwinds for stocks this year. As Porter noted in the July 15 Digest...

Financial-research firm FactSet explains exactly what's driving this market forward, despite all of the economic warning signs. So far this year, 41 different companies have spent more than $1 billion buying back their own shares. In the first quarter, U.S. corporations spent a total of $166 billion on share buybacks. That's a 15% increase over last year... and sets a new record annual pace for share buybacks.

But that could now be changing. According to the Wall Street Journal, S&P 500 companies spent just $127.5 billion repurchasing shares in the second quarter. This represents a 21% drop from the first quarter, and a 3.1% decline over the same period last year. As the Journal reported last week...

The decline may raise concerns that corporate leadership teams don't believe the economy will be strong enough to keep growing these programs. Analysts expect earnings for S&P 500 companies to fall for the sixth consecutive quarter during the July-to-September period, according to FactSet.

"Companies obviously pulled back significantly," said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, noting some had already spent significant amounts supporting stock prices when markets tumbled early in the year.

As Porter has explained, there are two big problems with the buyback boom we've seen in the market recently...

First, if earnings keep falling, buybacks can't keep growing. It's impossible for a business to sustain spending a majority of corporate net income on buybacks. The latest figures we've seen – as of an August report by investment bank Barclays Capital – noted that total buybacks and dividends in the S&P 500 equaled about 128% of annual earnings last year.

It should be obvious... Spending more than you earn is only possible with debt. And sooner or later, the bill comes due.

In short, if earnings keep falling – and as we detailed last month, they're on track to fall for a sixth straight quarter – it's only a matter of time before the buyback binge grinds to a halt.

Second, corporate managers are some of the market's worst investors. Buying back stock – at any price – will likely boost the value of their options... But it may or may not deliver real value to shareholders. They're also terrible at timing. As Porter put it...

There's a long and well-proven correlation between peaks in buyback amounts and peaks in the stock market. You'll notice that the same managers eagerly spending the corporation's cash on buying stock almost never buy the shares with their own savings.

The global debt bubble hits a mind-boggling extreme...

Speaking of debt, the International Monetary Fund ("IMF") reported yesterday that total nonfinancial-sector debt has ballooned to $152 trillion worldwide. This is the most in history.

The IMF says global debt-to-GDP has also soared to an all-time high of 225%, up from 200% just 14 years ago.

While the IMF said it is unclear exactly how this debt will affect the global economy, it noted that it could easily lead to crisis...

The empirical evidence in this chapter confirms that financial crises tend to be associated with excessive... debt levels in both advanced and emerging-market economies.

Dalio: Bonds are priced for disaster...

Legendary investor Ray Dalio – the founder of the world's largest hedge fund Bridgewater Associates – is no fan of long-term bonds today.

In a speech yesterday at the Federal Reserve Bank of New York's 40th Annual Central Banking Seminar, Dalio warned that bonds are offering one of the poorest risk-to-return propositions in history...

Rarely do we investors get a market that we know is overvalued and that approaches such clearly defined limits as the bond market now. That is because there is a limit as to how negative bond yields can go. Their expected returns relative to their risks are especially bad. If interest rates rise just a little bit more than is discounted in the curve, it will have a big negative effect on bonds and all asset prices, as they are all very sensitive to the discount rate used to calculate the present value of their future cash flows.

That is because with interest rates having declined, the effective durations of all assets have lengthened, so they are more price-sensitive. For example, it would only take a 100-basis-point rise in Treasury bond yields to trigger the worst price decline in bonds since the 1981 bond market crash.

As Porter has detailed in recent Digests, there is a way to bet against the bond-market bubble... to essentially "short" the most distressed issuers of risky debt – that can produce massive gains when the market turns.

He's launching a brand-new service called Stansberry's Big Trade to explain this strategy for individual investors. As he detailed last week, the market only has one path...

Corporate debt in the U.S. has consistently topped out at a little less than 45% of GDP. Historically, the debt cycle has turned at that point. Defaults rise, issuance declines, and a bear market begins. Today, that level sits at 45.4%.

This summer, the default rate on U.S. junk bonds spiked up to 5.1% according to credit-ratings agency Moody's, and is expected to hit 6.4% before the end of the year. Historically, default rates above 5% have signaled the beginning of a new credit-default cycle. That's likely to be especially true this time, given that the default rate hit record lows in 2014 and has been steadily rising since.

When these defaults begin, Porter says his "Big Trade" will be the best way to protect your portfolio and make 10 to 20 times your capital. That's why we're hosting a live webinar next month where Porter will share the full details.

Or, if you'd like to be the first to receive the 30 stocks that Porter plans to target with this strategy, you can begin your subscription to Stansberry's Big Trade right here.

New 52-week highs (as of 10/5/16): American Financial (AFG), EOG Resources (EOG), Nuveen Floating Rate Income Opportunity Fund (JRO), iShares MSCI Global Metals & Mining Producers Fund (PICK), and Constellation Brands (STZ).

After a few heated days in the mailbag, things have quieted down. Send your questions about Porter's "Big Trade" for him to answer in an upcoming Digest to feedback@stansberryresearch.com.

Regards,

Justin Brill
Baltimore, Maryland
October 6, 2016