Even in a Bubble, Value Hunters Can Find Opportunity
Revisiting our 'bubble' talk... No one thinks a 'death blow' is imminent... 'The correction has already been happening'... Even in a bubble, value hunters can find opportunity... As folks forget this asset class, an opportunity arises... Sounding the horn on a shunned commodity... Sign up for our FREE 'Bull vs. Bear Summit'...
I (Dan Ferris) shared a simple message in last Friday's Digest – and I'll say it again now...
This is a bubble.
I provided evidence... For one thing, the record surge of money into exchange-traded funds ("ETFs") is on track to hit a record $500 billion for the first time ever this year.
I offered assurances... Although some naïve folks might think so, the Federal Reserve is not using any sort of magic stock market levitation voodoo. It only controls its own narrative.
And I likened the whole thing to a Kabuki play... Market participants might be glued to the show right now, but there's no telling when the curtain will drop and everything will end.
Right on cue, the S&P 500 Index left its chair in the theater to start the week...
The benchmark index fell as much as 2.9% on Monday. It closed down 1.7% on the day.
The Chicago Board Options Exchange's Volatility Index ("VIX") is often called the market's "fear gauge"... And as the S&P 500 fell on Monday, the VIX hit its highest level since May.
The headlines cited worries about a looming payment deadline for highly indebted Chinese property developer Evergrande as the catalyst that sent global markets reeling... Hong Kong's Hang Seng Index closed at its lowest level since last October. (And my colleague Corey McLaughlin covered the fear of "contagion" among investors in Monday's Digest.)
But of course, the moment of fear quickly passed yet again. Most investors responded by doing what they've done for most of the past decade... They bought Monday's dip.
And as a result, the S&P 500 now trades higher today than it did at last Friday's close.
What sell-off?
If I wanted to be a pessimist – who am I kidding, of course I want to be – I would say the market is merely luring in as many dip buyers as possible before it delivers a "death blow."
Unfortunately, I doubt anybody believes a 'death blow' – a market crash or a sustained bear market – is imminent...
I would wager that many folks believe we'll never see another bear market again. The fact that we're in one of the biggest asset bubbles in history is on no one's mind today.
Nobody is truly scared of investing in stocks right now. But that doesn't mean the bear market hasn't already begun. That's how it works...
Nobody ever knows when a bear market begins until it's too late. The top goes by, and investors believe any drops after it are just dips to buy before the next all-time high is hit.
Bull market tops are non-events. Nobody knows they've happened until months after the fact... And by then, many folks have already lost a lot of their wealth on hopes and dreams.
On Monday, I got the slightest inkling that maybe this historic bull market has already ended...
It wasn't because the S&P 500 was falling throughout the day, though.
My hunch happened after I read one of Market Wizard and champion trader Mark Minervini's Twitter posts. (Regular Digest readers might remember him as the "$100 Challenge" guy.) As Minervini wrote...
As I've said a million times, to gauge the real "market," get off the indexes and look at individual stocks... 80% of S&P 500 stocks are down 10% or more and only 38% of Nasdaq stocks are above their 200-day moving averages. The correction has already been happening.
The correction has already been happening.
I'm not doing any victory laps yet, and you certainly won't catch me making predictions or calling tops. But Minverini's comments caught my attention...
The stats he cited are intriguing... They could be telling us that the market isn't doing as well as many participants think. Even though the S&P 500 is less than 2% from its all-time high of about 4,537 on September 2, the "individual stocks" tell a much different story.
Beyond that, even if the broad market hasn't peaked, at least one bubbly corner has already collapsed...
And it's creating a potentially interesting opportunity in one of the most popular speculative vehicles of the past year... I'm talking about special purpose acquisition companies ("SPACs").
These "blank check" companies sell shares to the public with the promise that they'll use the money they raise to acquire a business. Most SPACs go public at a share price of $10 ("par value"). They typically have two years to find a target company (sometimes longer). If they don't find a target company, they liquidate and return the $10 per share to investors.
SPACs serve a useful purpose... They can provide businesses with a low-cost alternative to a traditional initial public offering ("IPO").
But the essence of every bubble is to take a good thing and overdo it until it becomes a much riskier proposition. And it seems pretty clear that the market has overdone SPACs...
According to the website SPACInsider, a valuable resource for this corner of the market, 441 SPACs have gone public in 2021 (through this morning)... That's compared with 248 in all of 2020 and just 59 in 2019. The previous record was 66 SPAC IPOs in 2007.
Though the feeding frenzy seems like it's still on, the SPAC bubble has popped...
As investment bank Goldman Sachs reported in a September 15 research note, 93% of the 398 active SPACs at that time were trading below par value (below their $10 IPO price).
Remember, SPAC holders only need to hang on for two years... If the SPAC doesn't acquire a business in that span, investors get their $10 back. And yet, many folks have become so impatient with SPACs that they would rather sell at a loss than wait for the sure thing of getting their money back at no loss.
It appears that investors have become thoroughly disillusioned with SPACs.
And the thing is... that's why I'm now interested.
As a value investor, I prefer to buy an asset when most folks have been totally disheartened by its performance...
Today, SPACs fit that description better than almost anything else in the markets.
And right on cue, a new ETF has appeared to take advantage of the abundance of SPACs trading below par... CrossingBridge Advisors – an investment firm specializing in short-term debt strategies – launched the CrossingBridge Pre-Merger SPAC Fund (SPC) on Tuesday.
The fund buys SPACs trading at a discount to par. And it intends to sell them when they announce a merger. In the IPO announcement on Tuesday, CrossingBridge founder David Sherman said...
SPC is a renter, not an owner... In other words, we aim to capture the fixed income nature of pre-merger SPACs purchased at a discount-to-collateral value with a potential equity pop from shareholders reacting favorably to an announced deal. But we are not interested in being an equity investor post-business combination – that is a whole different ballgame.
Let's imagine that CrossingBridge invests in a pre-merger SPAC trading at $9.70 per share – a 3% discount to par. Then, the SPAC announces a merger that the market likes and its share price rises to $11 per share. That's a 13.4% return... And in most cases, it will occur within 12 to 24 months. If no deal is announced and the SPAC liquidates at its $10 par value, the ETF would still see a 3% return.
A CrossingBridge presentation shows the overwhelming majority of SPACs seeking deals today trade at discounts between 2% and 4%... That matches our hypothetical scenario.
Now, the returns might sound puny... But keep in mind that the ETF is billed as a "fixed income" alternative and is run by a company that specializes in short-term debt strategies.
I can't say for sure... but it sounds like this strategy might be right up CrossingBridge's alley. To borrow my phrase from the July 23 Digest, it seems like a "hedgehog" in this field.
If our hypothetical scenario winds up being anywhere near accurate...
CrossingBridge's strategy looks pretty good.
Just consider SPC's risk-reward proposition relative to the rest of the fixed-income world – which, as we discussed last week, is also in full bubble mode (more on that in a bit)...
Right now, two-year U.S. Treasury notes yield about 0.27% per year. The Fed's Two-Year High Quality Market Corporate Bond Spot Rate – a measure of high-quality, short-term corporate bond rates – is 0.5%.
Meanwhile, the two big "junk bond" ETFs yield 4.44% and 4.66%. So you would need to buy the riskiest debt in the market to beat the potential performance of SPC. And remember, most of the SPACs are just blank checks trading at a discount to their cash.
Of course, it's impossible to know how everything will play out for CrossingBridge and investors...
For example, the risk always exists that the market will, on average, not like the deals announced for the SPACs that CrossingBridge's ETF holds. That's the big concern...
We have no way of knowing what percentage of SPC's holdings will liquidate at par or what percentage will find deals at all. And beyond that, we could never know ahead of time which deals the rest of the market will like enough to propel their share prices above par.
That's why I must be clear... I'm not recommending CrossingBridge's SPAC ETF today.
It's tiny and illiquid. And it goes without saying that you would be foolish to buy into this ETF (or any others) without going to the firm's website and reading all the documentation.
I only wanted to point out its existence today to make a critical point...
SPACs were very obviously in a bubble earlier this year. That bubble has since deflated... And now, there's an opportunity attractive enough to be considered an alternative to traditional fixed-income assets.
Given that most folks probably had never heard of SPACs until a year or so ago, we've come full circle at hyper speed. In no time at all, this part of the markets went from early-stage opportunity... to full-blown bubble... to total washout and value opportunity.
I doubt anyone would be interested in this ETF if the bond bubble weren't as absurdly priced as ever...
I'm not saying it's absurd to label the SPAC ETF in that manner. Income investors have desperately sought higher yields for years... so it's just a great way to position the fund.
But that marketing angle for this particular fund is a valuable reminder that stocks aren't the only massive bubble around...
Income investors are more desperate than ever because bond yields have been scraping 5,000-year lows for a couple of years.
The amount of negative-yielding debt in the world has exceeded $12 trillion for most of the time since June 2019. As you can see in the following chart, it sits around $14.2 trillion today...
Said another way... Roughly $14.2 trillion – mostly Japanese and European sovereign debt – is guaranteed to lose money for everyone who holds it to maturity.
Will the global bond bubble become even more absurdly priced? Will nominal U.S. Treasury yields go negative? With the 30-year U.S. Treasury yield at 1.9% and the latest Consumer Price Index change at 5.3%, they're all already negative in inflation-adjusted terms.
So with that in mind... Is it so hard to believe that U.S. sovereign debt will eventually trade in the path of Japanese and European debt – below zero?
The Federal Reserve is just making the same futile attempts as those other regions' central banks. They're all trying to spur economic growth by attempting (and failing) to encourage lending within their jurisdictions... even though any first-year economics student can tell you that debt becomes less and less productive (deflationary) beyond a certain point.
Many folks think central banks have some magic ability to stop the markets from falling. But as I noted last week, no matter what central banks do, I promise you they aren't magicians... Their activities are subject to the same market forces as the rest of us.
If you believe the Fed can keep markets propped up indefinitely, you haven't been paying attention...
Remember last Friday when I quoted Jeremy Grantham?
The co-founder of asset-management firm GMO pointed out that the accommodative Fed of the past two decades has presided over two enormous blowups...
- The dot-com bust in the early 2000s
- The financial crisis of 2008 and 2009
If the Fed couldn't prevent those two colossal financial disasters from happening – mostly by being completely blind to the formation of the massive bubbles that preceded them –what makes anyone think it can prevent the next massive blowup from happening?
None of this is anything new, of course...
In late economist John Kenneth Galbraith's 1990 classic, A Short History of Financial Euphoria, he noted that "the extreme brevity of the financial memory" is one of the factors contributing to "the euphoria, the mass escape from reality, that excludes any serious contemplation of the true nature of what is taking place."
So if, like me, you're agog at the mass memory loss of past bubbles and the spectacular blowups that followed every one, take heart...
The blindness of those getting richer as the markets soar to unprecedented valuation levels is a sure sign that we're already living smack-dab in the middle of a massive bubble.
As the SPAC example we discussed earlier shows, however...
Even in the biggest, most absurd bubbles, you can still find opportunities to be exploited...
In that vein, I must mention oil and oil stocks once again today...
According to Bloomberg data, 30% of oil and gas producers are trading at less than 10 times cash flow today. In comparison, just 10% of all other North American stocks are below that threshold.
Meanwhile, West Texas Intermediate ("WTI") crude oil – the U.S. benchmark – trades at around $74 per barrel as we go to press... And after recovering from the COVID-19 panic, WTI has once again stabilized and traded consistently above $57 per barrel since February.
As we covered in the July 16 Digest, though, it's reasonable to expect the largely misguided "green energy" movement to discourage future oil and gas production... As supply declines, we'll get to the point when oil prices much higher than today's levels will become inevitable.
Plus, if you think inflation will keep edging higher in the coming years, oil and gas stocks should help you benefit from that trend... Those essential commodities will become more valuable relative to the shrinking value of the currency they're priced in – U.S. dollars.
Oil and gas isn't the only attractive commodity play out there right now, either...
The whole notion of owning "hard assets" – objects that are grown or mined – is more attractive than it has been in more than 20 years. You can see what we mean by comparing the S&P GSCI Commodity Index (commodities) with the Dow Jones Industrial Average (stocks) since 1990...
In short, the overall commodities sector is the cheapest it has been relative to stocks since the lows of the dot-com bubble. And it's worth pointing out that the S&P GSCI Commodity Index went on an incredible run after that... It soared more than 500% from November 1998 to June 2008.
This is a blanket observation, of course... And it would require substantial investigation to wind up with specific, actionable stock recommendations to maximize your returns.
I can't help but mention that my colleague Mike Barrett and I have several hard-asset and commodity-related stocks in the model portfolio of our Extreme Value monthly newsletter...
We've identified ways to help our subscribers invest in gold, oil, and other commodities. And through our research, we've found that these investments are far superior and generally carry less risk than more direct plays like mining companies and oil and gas producers.
My point is, where dangerous market conditions exist – and regular Digest readers know I think the conditions are highly dangerous today – there are also excellent opportunities.
That brings me to one final takeaway before we wrap up today...
When investors fall so deeply in love with one set of assets that they inflate a massive bubble – like what's continuing to happen in the broader stock market... there's usually another asset somewhere that investors have either shunned or simply forgotten about.
SPACs are being forgotten and commodities are being shunned today. For that reason, they're the types of ponds I'd rather be fishing in these days.
Frankly, this is a microcosm of what we can expect from most stocks in the years ahead...
The overall market has been booming since the bottom of the financial crisis in 2009 – the unpleasantness of March 2020 notwithstanding. And we're still in full-blown bubble mode...
The value opportunity in most stocks has yet to appear. But as someone who spends my days hunting for value, it's good to see it appear in at least some corners of the market.
We're not there yet with the broader stock market... but we will be eventually.
Make no mistake, I'm as bearish on stocks as ever...
That's a big reason why I agreed to take part in an urgent event for all Stansberry Research readers next week... I'll be joined by two other veteran editors from our company – Retirement Millionaire editor David "Doc" Eifrig and True Wealth editor Steve Sjuggerud.
It's pretty clear to Digest readers that Steve is as bullish as they come – and well, I'm not.
So I'm planning to go head-to-head with him about the markets during our "Bull vs. Bear Summit"... It's set to happen next Tuesday night, September 28, at 8 p.m. Eastern time.
And we don't want folks to go away empty-handed, either... So just for tuning in, you'll receive the name and ticker symbol of the "No. 1 most dangerous stock in the world today."
I know you won't want to miss a second... Reserve your spot for this FREE event right here.
New 52-week highs (as of 9/23/21): Analog Devices (ADI), Asana (ASAN), AutoZone (AZO), Continental Resources (CLR), Formula One Group (FWONA), Intuit (INTU), Cheniere Energy (LNG), OptimizeRx (OPRX), Invesco S&P 500 BuyWrite Fund (PBP), Thermo Fisher Scientific (TMO), Viper Energy Partners (VNOM), and Verisk Analytics (VRSK).
In today's mailbag, more feedback on Kim Iskyan's Wednesday Digest about global supply-chain issues. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Note that while things are presently not popping out of the supply chain into customers' hands, the people that put things in at the top are also slowing down. No point making or growing things there is no way to ship. Like a traffic slowdown on the highway that persists for some time after the event creating it (and until traffic actually falls off), we are likely a couple of years away from full supply chain recovery." – Paid-up subscriber Dave M.
Good investing,
Dan Ferris
Eagle Point, Oregon
September 24, 2021