Beware the Big Bezzle

The next major fraud... Enron and Madoff are still etched in our minds... Beware the big bezzle... Start with your own portfolio... The Economist roller-coaster cover... Your new assignment...

The 'big one' is out there...

By "the big one," I (Dan Ferris) don't mean a big market crash... or any kind of major asset price movement.

No, I'm talking about the big fraud, the financial scandal that will etch itself permanently into our collective memory like Enron did in 2001 and Bernie Madoff did in 2008...

There have been many scandals over the past several decades, but Enron and Madoff were big and bad enough never to be forgotten, even though they happened during ugly bear markets when most of us had other more pressing priorities at hand... The markets of course have recovered to all-time highs, but memories of Enron and Madoff remain strong.

Nothing like either episode has happened since... The Theranos scandal is the biggest recent financial fraud, but it's paltry in comparison.

In that scheme, Steve Jobs-wannabe Elizabeth Holmes put on a black turtleneck, faked a deep voice, and took in more than $1 billion in venture capital investments to finance an instant blood-testing system that, in the end, didn't work...

But it's just not big enough...

Enron's annual revenues topped out near $100 billion. Its peak market cap was around $70 billion... Then, the company went bankrupt and its stock sank to zero.

Madoff claimed some $65 billion of fabricated gains, but it's estimated there was never more than $18 billion in actual money... of which $14.5 billion has been recovered to date.

Theranos had no significant revenue... Investors gave Holmes roughly $1.4 billion in financing. The company's peak valuation was $9 billion...

Small potatoes, relatively speaking... Anybody who wants a permanent place in our scandal memories will need to up the ante, maybe to $100 billion or so.

Also, the deep voice, black turtlenecks, and the goofy wide-eyed expression Holmes often wore all added too much levity... And ultimately, what happened is that a handful of wealthy investors lost their money ‒ it's sort of OK to laugh it off.

Enron and Madoff were 100% dark, nasty episodes in which key players – including Madoff's own son – committed suicide. We're still not laughing about either event. I doubt we ever will.

Maybe I'm too impatient...

Maybe I need to wait for a bear market to set in...

It makes sense that scammers are less likely to be found out while asset prices are high. Clients don't ask questions when they're flush with big gains...

When losses get large enough, shareholders want to know what the hell happened to their money... Warren Buffett says you don't know who's swimming naked until the tide goes out...

The tide is still high...

Enron unfolded and finally went bankrupt on December 2, 2001... The Nasdaq Composite Index was down 61% by then, having peaked 21 months before.

Madoff was arrested on December 11, 2008, after the S&P 500 Index had fallen 43%, 14 months after its pre-crisis peak...

Even if we are in a bear market – it's impossible to know at this point – the last two bear markets suggest we won't see the big scandal until the S&P 500 is down at least another 30% or so...

So far in 2022, the worst damage among the big indexes has been to the Nasdaq, which trades about 14% off its November 19 peak closing price of 16,057.44... That barely qualifies as a correction.

Maybe scandals just don't get uncovered at the top. The eponymous schemer himself, Charles Ponzi, opened for business in January 1920, and pleaded guilty to one of the 86 counts of mail fraud against him on November 1, 1920... The Dow Jones Industrial Average fell 33% that year.

When I recommended shorting Lehman Brothers in April 2008, I noted that the assets Lehman had to report at market prices had fallen in value, while asset valuations determined internally by Lehman had risen... It was suspicious.

As the housing bubble turned into the housing bust and then into the Great Financial Crisis, pushing virtually all asset prices down, it became impossible to hide the truth...

The Fed bailed out all the other big Wall Street banks and made an example of Lehman, allowing it to fall into bankruptcy on September 15, 2008...

Today, with the big equity indexes and bond prices still not far below their most expensive valuations in all recorded history, it's unlikely we'll see anything resembling Enron, Madoff, or Lehman emerge anytime soon...

You may want to ask, 'What's with the history lesson?'...

Here's the point...

If you just like to read about scandals, you can afford to wait for the next big, era-defining scandal to happen... Most folks won't start talking about Enron and Madoff until after the next big one.

But if you're an investor, that's too late. It's like getting bearish at the bottom of a bear market... It's totally useless except as a contrarian indicator.

The time to think about the big, hairy risks that nobody sees coming is before they blindside thousands of investors to the tune of tens of billions of dollars... The time to think about what might go horribly wrong with your investments is before anything even begins to go horribly wrong.

With the S&P 500 and Dow Jones trading within 6% of their recent highs, it's doubtful we'll see "the big one" hitting the headlines right now...

But what if this is the beginning of a bear market and the big one is currently bubbling beneath the surface, ready to emerge in six to nine months?

You'd look back to this moment and say, "I wish somebody had warned us about stuff like this." A (very) few of us do warn you... but our voices tend to get lost in the bullish noise.

Don't expect me to make any predictions about exactly what the next big scandal will be or when it'll break... Like most investors, I'd never heard of Bernie Madoff before December 2008.

Enron was in the news months before it finally blew up, but its bankruptcy still took a lot of investors by surprise... You may remember the stories of Enron employees who had their whole retirement in the company's stock ‒ and lost it all.

It underscored how much the scandal blindsided investors... Not even the insiders knew.

Though Enron made headlines for months before blowing up, and Madoff was well-known in the securities industry for decades before he was arrested... both Enron and Madoff made very few investors suspicious enough to ask hard questions before they completely unraveled.

Even worse, they were both widely lauded as unparalleled successes not long before their frauds came to light...

To avoid the next great scandal, first look for the bezzle...

In his 1954 classic, The Great Crash 1929, economist John Kenneth Galbraith coined the term bezzle...

At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country's businesses and banks.

Galbraith dubbed that inventory of undiscovered embezzlements "the bezzle."

Used more broadly, it describes any moment when a scammer has his gains and the victim has yet to learn he's been scammed...

In financial markets, the bezzle might refer to the difference between inflated value ‒ whether fraudulently or not ‒ and true value.

The $50.5 billion difference between the $65 billion Madoff's clients thought they had and the estimated $14.5 billion they've actually recovered is a perfect example of bezzle... Considering its equity went to zero in bankruptcy, Enron's entire peak market cap of $70 billion also qualifies as bezzle...

The bezzle rises and falls with asset prices. When valuations are high, a large inventory of bezzle has accumulated... When they're low, the bezzle is too small to matter much.

With stock and bond prices still in spitting distance of their most expensive valuations in all recorded history, there has to be one hell of a lot of bezzle out there...

Bezzle is not that hard to find, but it's a shy creature...

The moment the masses discover it, it tends to disappear pretty quickly... That's why you need to find the bezzle before anybody else does... or at least avoid having your assets mixed up with it.

Perhaps you think a fair amount of bezzle has already evaporated from bubbles in individual stocks, like Peloton Interactive (PTON), or from SPACs, or sectors like cannabis, clean energy, and the sketchy cryptos.

I would have to agree. But if you believe as I do that we're still in the biggest asset bubble of all time, then you also have to assume that it has created more bezzle than any previous bubble... Only the easy bezzle has been found. The big bezzle has yet to be unearthed.

Some of it is not hard to find... For example, there's still a ton of bezzle left in the two big meme stocks, GameStop (GME) and AMC Entertainment (AMC).

Anybody buying them for anything but a straight-up gamble right now is deluding himself... They're indebted companies in dying industries. Now they're trying to get into cryptos and non-fungible tokens ("NFTs"). It's like watching a failed mining stock become a dot-com company in early 2000… It's embarrassing.

It's not hard to find large bezzle inventories...

Just ask yourself, what assets are widely touted today as the answer to some great problem (real or made up) by a large, unwavering group of true believers... and maybe also consistently cheered throughout financial media?

Cryptocurrencies and NFTs certainly qualify... no matter how useful the technology behind them may ultimately become.

If you've ever said anything the least bit critical about a cryptocurrency on social media, you've seen the true believers come down on you with a vengeance... They'll say things like, "Have fun staying poor," or maybe just, "ngmi" ‒ "not gonna make it."

When emotions run that high and conviction is that unshakable in financial markets – especially with a totally new asset class – there's a reasonable chance that big trouble is brewing.

Among popular equities today, electric-vehicle maker Tesla (TSLA) strikes me as having a higher-than-average probability of lighting hundreds of billions of market cap on fire over the next few years... Its current market cap of $906 billion is higher than that of Toyota Motor (TM), Volkswagen (VWAGY), Ford Motor (F), General Motors (GM), BMW (BMWYY), Honda Motor (HMC), Mercedes-Benz (DMLRY), Nissan Motor (NSANY), and Hyundai Motor (HYMTF) combined.

That valuation assumes the rosiest possible future for Tesla... It assumes none of those other car companies will ever compete effectively with Tesla, and that Tesla will grow many times its current size in revenues, and will become consistently highly profitable...

A dubious trifecta of individually dubious assumptions at best...

Tesla has plenty of downside potential left, despite trading 30% off its November 4 high closing price of $1,229.91... Tesla bulls have not relented. Their accounts are loaded with bezzle.

So look around ‒ and start with your own portfolio...

I've recommended selling speculative garbage more than once... I'll keep reminding you until it's too late. Then, after the S&P 500 has fallen 40% or 50%, I'll let Jim Cramer and the mainstream media start yelling at the top of their lungs about hitting the "sell" button while I shop for bargains.

Don't get me wrong... They're nice people when you meet them at cocktail parties, but Cramer and his talking-head friends aren't the quickest of cats at the best of times when it comes to identifying and avoiding big risks.

But I don't think of myself as the bearish guy... I'm the guy who's trying to balance more than a decade of bullish bezzle creation with what I believe is a series of prudent warnings.

Still, to add some balance to my own message seems reasonable... and when a bearish guy like me sees a massive anecdotal sign that the top is farther away than he might have expected, I need to tell you about it... or I'll have trouble looking in the mirror.

That anecdotal sign is none other than the cover of the Economist... one of the all-time great indicator sources. The latest cover features a picture of a roller coaster that resembles a crashing stock chart with the headline...

When the ride ends

What would happen if the markets crashed?

A bearish headline on the cover of the Economist amidst a hawkish Federal Reserve narrative... in the same week that the U.S. and U.K. are the only Western nations sounding the alarm over a possible Russian invasion of Ukraine, is about as good of an anecdotal "buy" signal as you're likely ever to see.

Whether it's a short- or long-term signal – or any kind of signal at all – remains to be seen...

So... which one would surprise you more...

The Economist publishing a bearish cover near the top of a bull market... or the S&P 500 rising despite inflationary and monetary policy headwinds?

Markets can rise during inflation and during Fed tightening cycles... They've done it before and will do it again. But the Economist not functioning as a contrarian indicator?

That would definitely be the bigger surprise.

I personally don't invest based on anecdotal indicators... I'm just trying to remind you that there's a reason why I don't call tops or bottoms, and too many investors don't find the large inventories of bezzle until it's too late...

Investing is hard... Don't make it harder by holding speculative junk when the bezzle has barely begun to deflate.

Keep your money in great businesses and assets highly likely to hold their value for the long term... Obviously that group didn't include Enron, Madoff client accounts, or Lehman Brothers shares.

It obviously didn't include Peloton... And it doesn't include Tesla, meme stocks, most of the 17,500 cryptos out there, nor does it include the primitive CryptoPunks NFT that sold for nearly $24 million worth of Ethereum over this past weekend... Whoever bought it owns a boatload of bezzle right now.

That's it. That's your new assignment...

Avoid the bezzle.

Stansberry Investor Hour Is Moving to a New Day

Starting next week, new episodes of Stansberry Investor Hour will air on Monday evenings – giving host Dan Ferris a chance to reflect on the market news from the previous week and weekend that matters most to you and your investments. We're excited for the extra value this change will bring and hope you are too... In the upcoming episode on Monday, Dan talks with Peter Boockvar, the chief investment officer of $8 billion wealth-management firm Bleakley Financial Group... One of the big themes Peter sees right now is a global, unstoppable force of people wanting to break out of their pandemic bubbles and travel.

Dan's interview with Peter will air on the Stansberry Investor Hour website and everywhere you listen to podcasts on Monday, February 21.

New 52-week highs (as of 2/17/22): Altius Renewable Royalties (ARR.TO), Enstar (ESGR), Coca-Cola (KO), and United States Commodity Index Fund (USCI).

In today's mailbag, a question about the new Stansberry Research Investor Platform... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"The new platform is awesome! So glad I'm an Alliance member, too.

"Once I leave the homepage, there's no way to get back other than by hitting the back button. Any way you can place a 'Home' button in the 'Tools' drop-down navigation box so we can easily get back to the homepage?" –Stansberry Alliance member Anthony K.

Corey McLaughlin comment: Thanks for the note, Anthony. Good question/suggestion! The "home" button is the Stansberry Research logo in the upper left of the screen. If you click that, it'll take you to the home page.

Good investing,

Dan Ferris
Eagle Point, Oregon
February 18, 2022

P.S. The markets and our Stansberry Research offices are closed Monday for Presidents' Day, so we won't publish on February 21. After the Masters Series this weekend, you should expect to receive your next Digest on Tuesday.