A New Bullish Sign for Commodities

Another warning on the 'buyback boom'... U.S. companies are now spending more on buybacks than anything else... Signs of a top in the credit markets... One of the largest sales of 'junk' debt in history... A new bullish sign for commodities...

Regular Digest readers know U.S. corporate share repurchases, or 'buybacks,' are booming...

Companies have already announced buybacks of more than $762 billion so far this year, putting them on pace to exceed $1 trillion for the first time.

But buybacks aren't booming in nominal terms alone. New research from investment bank Goldman Sachs shows they're also surging as a percentage of total corporate spending. As Bloomberg reported last week...

According to Goldman Sachs, aggregate share repurchases (or buybacks) rose by nearly 50% to $384 billion in the first half of 2018. That tops the $341 billion spent on capital expenditures...

"Buybacks are garnering the largest share of cash spending by S&P 500 firms," writes chief U.S. equity strategist David Kostin. "Capital spending has typically represented the largest single use of cash by corporations, a position it has held for 19 of the past 20 years."

In other words, for only the second time in the last two decades, companies are now more focused on "juicing" earnings per share than on expanding their actual businesses. Financial engineering has taken the place of legitimate earnings growth.

The last time buybacks exceeded capital spending?

That was 2007... just before the worst financial crisis in a generation.

Again, this won't end well. But as Porter explained on Friday, this debt-fueled buyout boom could continue to push stocks higher in the meantime...

The big trick in this credit bubble is the central banks' intervention into the corporate-bond market, which has transformed corporate junk bonds into investment-grade bond indexes that essentially trade at par with sovereign bonds.

Presto: A booming global economy and stock market, along with enormous speculative bubbles like bitcoin and pot stocks.

I'll give you three guesses as to what will happen next... In [Friday's] Wall Street Journal, James Mackintosh, editor of the Streetwise column, cites a Citigroup report that warns explicitly about the huge volume of corporate credits that the credit-ratings agencies will soon downgrade...

The volume of these downgrades cannot possibly be absorbed into the high-yield ("junk") bond markets without a serious jump in interest rates. And a rate spike would cause a huge decrease in available credit... just as trillions of dollars' worth of corporate debts must be rolled over between 2019 and 2020.

It's going to be a horror show... But until then, the trillions of dollars in new corporate debt will power huge increases to share buybacks, which will convince the public that stock prices can only go higher. That's how the stage will be set for the Melt Up.

Speaking of the absurd excesses in the corporate credit markets today...

There may be no better example than private equity firm Blackstone's latest deal. Last week the firm agreed to buy Thomson Reuters' financial data business (which will soon be renamed "Refinitiv") for $17 billion.

More than two-thirds of that sum will be financed by debt... representing the single largest "leveraged buyout" of 2018, as well as one of the biggest sales of speculative-grade debt in history. And the details are downright frightening. As financial newspaper Barron's reported over the weekend...

Refinitiv's private-equity buyers say that the leveraged buyout will leave the company with net debt that is 5.2 times the size of its earnings before interest, tax, depreciation and amortization (EBITDA).

But investors say that figure is optimistic. They point to a clause buried in a sub-footnote of the offering documents, which explains that the EBITDA figure includes $650 million of cost savings that aren't expected to be realized until "the end of the third fiscal year" after the deal is completed.

Without that $650 million, the leveraged buyout will leave the company with debt 7.2 times its EBITDA for the year ended June 30, and 7.7 times EBITDA for the year ended Dec. 31.

To put this figure in perspective, consider that now-bankrupt toy company Toys "R" Us – which failed earlier this year – carried a debt-to-EBITDA ratio of less than 7, according to Bloomberg data.

Meanwhile, the deal's protections for investors – known as "covenants" – are among the weakest we've seen in this credit cycle to date. More from the report...

One of these provisions allows Refinitiv's private-equity owners to pay themselves dividends in scenarios where a normal contract would not allow such a payment, according to Covenant Review analyst Scott Josefson. He estimated that Blackstone and the other sponsors could pay themselves $2 billion in dividends on the day of the deal under the preliminary debt documents. The covenants could also permit the owners to pre-pay unsecured bonds before the secured debt, which would normally come first, he wrote in a note.

Another section of the preliminary debt contracts allow the company to include future income from newly signed contracts as part of its EBITDA...

And finally, the preliminary bond contracts allow the company to sell itself to different owners without redeeming the debt under certain conditions. While this is a common feature in European high-yield contracts, the standards in this contract are even looser than those usually found in Europe, according to Covenant Review.

What could possibly go wrong?

Of course, none of these red flags stopped folks from practically falling over themselves to buy. According to Barron's, there was more than $30 billion worth of bids on this debt, more than twice the amount offered.

Regular readers know we've also been closely following the precious metals markets...

In short, we're now seeing the unmistakable signs of a significant long-term bottom in gold and silver, as well as their lesser-owned "cousins" platinum and palladium.

But we'll remind you precious metals are far from the only opportunity we're tracking in the resource markets today. A number of commodities have the same incredibly bullish potential. As Porter explained in the July 6 Digest...

Sooner or later, the same kind of move we've seen in gold will happen in every major commodity sector. Wherever you look in the commodities complex, you will find blown-out sectors that mirror what we saw in gold back in 2015.

Across the board, commodities are down about 80% from their peak...

What's going to happen next is the biggest commodity rally of all time... I can't tell you exactly when it will start. But I'm 100% certain that over the next 12 to 36 months, commodities and commodity stocks will experience huge gains that dwarf the returns of the stock market.

Our colleagues Ben Morris and Drew McConnell agree...

In fact, as they pointed out to their DailyWealth Trader subscribers last week, this big rally may already be underway...

As you can see in the chart below, the [Thomson Reuters/CoreCommodity CRB Index] fell 50% from its June 2014 high through its February 2016 low. But since then, it has put in a series of "higher highs" and "higher lows." It's in an uptrend...

As they noted, big bull markets often begin when most folks aren't paying attention...

And that certainly seems to be the case today. The broad commodities market (as tracked by CRB) is up more than 20% from its February 2016 lows. Yet we'd wager most investors have no idea – or are indifferent if they do.

History suggests this is an incredibly bullish sign. But it's not the only one. The CRB recently staged a small "breakout" that suggests the next leg higher is about to begin. More from Ben and Drew...

In this shorter-term chart, you can see that commodities have pulled back about 8% since their May 23 peak. But over the past few weeks, the CRB turned higher and broke out of its downtrend...

Commodities experienced a brutal bear market. And they're now starting to rise quietly, beneath most investors' radars.

We are not saying this is the exact moment to shift a huge portion of your money from stocks into commodities... Stocks still look great today. But commodities are looking better and better.

If you don't have some of your portfolio allocated to commodities yet, this is a great time to "dip your toe in the water."

New 52-week highs (as of 9/21/18): Automatic Data Processing (ADP), Blackstone (BX), Cisco (CSCO), ETFMG Prime Mobile Payments Fund (IPAY), Ingersoll Rand (IR), Microsoft (MSFT), ProShares Ultra Health Care Fund (RXL), Service Corporation International (SCI), and Viper Energy Partners (VNOM).

In today's mailbag: Feedback on Porter's latest Friday Digest... more reader reactions to the new Apple Watch... and a question from a worried subscriber. Let us know what's on your mind at feedback@stansberryresearch.com.

"Porter, I enjoyed your credit bubble masterpiece thoroughly. Having seen many bubbles in my 81 years (gold, Silver, toy trains, US coins, dot com, the mortgage-housing bubble, paintings and collector cars) the next crash ought to be something that will literally be shock and awe. Thank you for putting it all in black and white." – Paid-up subscriber Charles P.

"Spot on analysis of what is coming – granted wish it wasn't so, but I totally agree with your well thought out presentation." Paid-up subscriber R.S.

"[Regarding the negative feedback on the Apple Watch], I think there's always a balance to be struck as we transition to new technologies; somewhere between being an early adopter or one of the last holdouts being forced into it because there aren't any more phone booths to call from." – Paid-up subscriber Otis G.

"Okay, BSEE (Electrical Engineering) & BS (Math), both in 1971. For a while I was even in Graduate School in Computer Science and a Research Assistant to the Chairman of the Department. Most of my working career revolved around computers. I love tech. That said, the Apple Watch scares the crap out of me. Do you really not see the very real threat to civil liberties in a device that ALWAYS has your GPS co-ordinates and the ability, on its own, to make phone calls? Further, an insurance company will refuse to sell you insurance unless you join the Borg? You are encouraged by the increase in margin, but I see it as a chilling harbinger. BTW, I don't want Apple to have that kind of surveillance capability on me any more than I want it from government." – Paid-up subscriber PES

"I recently read that [this] week the S&P 500 will be reconfigured. The gist of the article said this could trigger a huge drop in the average. Could you please speak to this in an update? Time is urgent for information as I believe the change will be early [this] week." – Paid-up subscriber Dave L.

Brill comment: Thanks for the question, Dave. You're correct... After the close this Friday, September 28, S&P Dow Jones Indices will be changing the way it classifies some of the stocks in the S&P 500 Index. Fellow index provider MSCI will be making a similar change on December 3.

We discussed these changes in detail in the September 4 Digest. In short, while these changes could cause some short-term volatility in the specific stocks that are being reclassified, they're unlikely to have any significant long-term effects on these stocks or the market in general.

Regards,

Justin Brill
Baltimore, Maryland
September 24, 2018