Beware a Bond Market 'Fire Sale'

Central banks sound the alarm on corporate credit... A big risk to investment-grade debt... Beware a bond market 'fire sale'... A second chance to buy Dan Ferris' No. 1 idea of all time...

Earlier this week, the Bank for International Settlements ('BIS') made a startling admission...

In its latest Quarterly Review, published on Tuesday, the so-called "central bank to the world's central banks" warned that all is not well in the corporate credit markets. From the report...

The share of corporate bond issuers with the lowest investment grade rating – BBB and equivalent – has risen in the United States and Europe since 2000... As of 2018, the share of corporate bond issuers rated BBB stood at about one third in the United States and at nearly half in Europe.

Now, this particular warning is nothing new...

In recent months, we've seen a number of reports on the huge – and growing – amount of investment-grade debt that's just a single downgrade from "junk" status.

(Of course, Digest readers have been aware of this problem even longer... Porter and his team of analysts have been covering this story closely for the past couple of years.)

But the BIS didn't stop there... It also warned that this debt could trigger massive losses in the retirement accounts of millions of Americans. More from the report...

Rating-based investment mandates require portfolio managers to hold assets above a minimum credit quality. Such mandates often apply to corporate bond mutual funds, and allow investors to easily choose the desired risk exposure, often focusing on the investment grade segment.

Since the [2008 financial crisis], investment grade corporate bond mutual funds have steadily increased the share of BBB bonds in their portfolios. In 2018, this share stood at about 45% in both the United States and Europe, up from roughly 20% in 2010.

As interest rates remained unusually low post-[financial crisis], portfolio managers were enticed by the significant yield offered by BBB-rated bonds, which was substantially higher than for better-rated bonds.

In other words, 10 years of insane easy-money policies have wreaked havoc in this area of the market, too...

In search of yield, fund managers have been pushed to load up these traditionally conservative bond funds with more of the riskiest investment-grade debt than ever before. As a result, investors in these "safe" funds are unknowingly at risk of massive losses when the credit cycle inevitably rolls over...

If, on the heels of economic weakness, enough issuers were abruptly downgraded from BBB to junk status, mutual funds and, more broadly, other market participants with investment grade mandates could be forced to offload large amounts of bonds quickly.

The report notes that the likelihood of any such "fire sales" ultimately depends on a "sufficiently large" number of BBB companies being downgraded in a short period of time. But if the total percentage of companies downgraded in this cycle reaches anywhere near the 11.4% seen at the peak of the last cycle in 2009, even conservative estimates suggest it's a real possibility.

The stark assessment from the BIS made headlines this week...

But Porter and his research team have been all over this story, too. As Stansberry's Credit Opportunities editor Mike DiBiase reminded subscribers most recently in November (emphasis added)...

The high-yield-bond market is on the verge of growing much larger. That's a major problem...

Many institutional investors – like pension funds, insurance companies, and endowments – have policies that prevent them from investing in anything other than investment-grade debt. So if any BBB-rated bonds in their portfolios are downgraded to junk status, these institutions will have no choice but to unload the bonds immediately...

As this new wave of junk debt floods the market, bond prices across the board will plunge... Investors simply aren't going to devote that much of their capital to these riskier bonds.

For unprepared investors, it's becoming clear... We're marching closer to a tragic ending.

If you've been with us for long, you may be tiring of these warnings...

But we urge you not to dismiss them. We're moving closer to a reckoning... and just because these problems haven't "mattered" to the markets yet, it doesn't mean they won't soon.

As Mike noted in the Digest last week, this credit bubble can't continue to inflate forever. Sooner or later, it will find a "pin." And when it does, the consequences are likely to be dramatic and swift.

We should also mention that the BIS wasn't alone in warning about these problems this week...

That same day, Robert Kaplan – president of the Federal Reserve Bank of Dallas – also sounded the alarm. But he was a bit less candid than his colleagues at the BIS.

You see, Kaplan conveniently failed to acknowledge the role the Fed's easy-money policies played in creating this mess. Instead, he took the opportunity to encourage a continuation of these disastrous policies today. As news service Reuters reported...

[A] borrowing binge by U.S. companies could make a slowdown in the world's biggest economy even more painful and is one more reason the Federal Reserve was wise to put interest rate hikes on hold, Robert Kaplan, president of the Dallas Fed, said.

"It's something that I'm aware of, which sort of reinforces for me why I feel we should be taking no action for some period of time," Kaplan said in an interview with Reuters...

Companies with big debt loads may be more likely to cut spending and hiring in a downturn, "and the danger is that with a sufficient enough slowing, you'll have a greater deterioration in credit quality than you would otherwise, which could in turn amplify the slowdown," Kaplan said.

By all accounts, he said this with a straight face.

Of course, corporate credit isn't the only problem...

Regular readers know U.S. consumers have been on a borrowing binge of their own. But unlike the lead-up to the last financial crisis, this time the bubble isn't in mortgage debt...

Rather, it's in virtually every other form of household debt. This has led to new all-time highs in student loans, auto loans, and – as of last quarter – credit-card debt.

As we've discussed, much of this debt is owed by those Americans least able to afford it. But make no mistake, this is not an isolated problem...

A huge percentage of the population – including many people who earn relatively high salaries and who would be considered "rich" by most people – have become dependent on cheap debt to survive.

Like the borrowing binge in corporate debt, this one can't go on forever... and it will not end well. (Our colleague Bill McGilton will dive deeper into this issue in the Digest next week.)

These risks are among many important reasons why we've advised a cautious stance lately...

They could trigger both the next recession and a severe bear market. And it could happen suddenly, before most folks will have time to prepare.

But it's important to remember that not everything will do poorly in this environment. As regular readers know, we've recently discussed several opportunities that are likely to do well regardless of what happens to the broad market or the economy.

One of our favorites is commodities...

These assets are among the few in the world that haven't benefited from the global boom of the past few years. Across the board, commodities have fallen as much as 80% from their peak. Today, they've become as cheap and hated as any time in history. And gold is particularly attractive today.

Another huge potential opportunity is in so-called "value stocks." Like commodities, these stocks have more or less been left behind by the current bull market. And as Extreme Value editor Dan Ferris noted in the November 9 Digest, history suggests these stocks are likely to dramatically outperform the market over the next five to 10 years.

Why do we bring this up today?

Because last year, Dan discovered one opportunity that is set to benefit from both of these trends.

It's a little-known stock trading at a huge discount to the underlying value of its business. In fact, Dan says this company has the biggest "margin of safety" of any he's ever seen in the markets. He believes it's a situation where investors could double or triple their money even if almost nothing goes right in the future.

Better yet, he says it also happens to be one of the best-run and most profitable gold businesses in the world.

All told, Dan says this stock is the single greatest opportunity he's ever come across in his 20-plus years in the investment-newsletter business... He believes it could go on to become the first "20-bagger" in Stansberry Research history.

Again, Dan originally recommended this stock to his Extreme Value subscribers last year...

Unfortunately, the opportunity wasn't available for long. Shares jumped above his maximum buy price a few weeks later, and remained well above it for much of the past year.

But recently that changed... Thanks to December's broad-market swoon, shares dipped just enough to put them back into buy range, giving interested subscribers a second great chance to buy.

Dan recently sat down for a rare on-camera interview to discuss this opportunity in detail. Click here to view it now. If you're interested, please don't delay. Shares are already moving higher again, and the stock may not remain a "buy" much longer.

New 52-week highs (as of 3/7/19): Essex Property Trust (ESS) and Invesco Value Municipal Income Trust (IIM).

In today's mailbag: More thoughts on Wednesday's "unusual" Digest... and a reader weighs in on CRISPR gene editing. As always, send your notes to feedback@stansberryresearch.com.

"Just a quick comment on the Altria (MO) recommendation in your recent Digest. I'm an Alliance member. The MO recommendation has appeared in multiple publications. Anyone who wanted to get in has had plenty of opportunities to get in. To be honest I did take positions in MO and PM.

"Additionally, this stock has a large trading volume and the impact was small; it's not like sharing a Venture Value/Venture Tech recommendation. I have no problem with you sharing the MO or other recommendations as long as it doesn't become a weekly event." – Paid-up Stansberry Alliance member K.L.

"I enjoyed and was fascinated by [Thursday's] Digest on gene editing. CRISPR holds a lot of potential, but like any quickly developing science, it can move ahead of the ethics involved.

"I read about CRISPR not too long ago in a Discover magazine article. According to the article, using DNA editing, CRISPR sometimes didn't go exactly where it was supposed to, so this was a concern about its use. The article mentioned that scientists were starting to use CRISPR to edit RNA, which seemed to be less likely to go off track. This is what I first thought today's Digest was about. Keep up the good work." – Paid-up Stansberry Alliance member Bert D.

Regards,

Justin Brill
Baltimore, Maryland
March 8, 2019