Get Out of Junk Bonds Now

'Last call' for Doc Eifrig's 'triple sized' income opportunity... Get out of junk bonds now... The high-yield 'frenzy' is spreading... A 'nightmare scenario' in France... Your chance to learn more about 'cryptocurrencies'... P.J. O'Rourke: The Tax Reform We Need and Want, Part II...

It could be Dr. David "Doc" Eifrig's biggest income idea to date...

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Doc's brand-new recommendation will be sent to his Income Intelligence subscribers this evening. So if you aren't a subscriber, it's not too late. You haven't missed anything... yet.

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Regular Digest readers know Porter has been warning about the growing risks in the corporate-bond market for some time...

And early last year, it appeared the market was finally waking up to these risks. Investors rushed for the exits and dumped high-yield (or "junk") bonds in a panic.

But it didn't last long. The crash in oil prices – which had amplified the credit-market stress – found a bottom. And the spread of negative-interest-rate policy ("NIRP") drove investors back into riskier debt in search of yield.

Today, it's almost as though last year's panic never happened. Investors are once again buying high-yield debt without care. Yet beneath the surface, risk is still rising. As Porter explained in the April 7 Digest...

So far in 2017, we've seen 228 companies suffer a credit downgrade. That's slower than the first quarter of last year (324), but it's still more for any first quarter between 2010-2015. The high-yield "junk" bond default rate has improved a bit, too. It reached 5% in 2016 and now stands at 4.4%.

The rally in oil prices has given some companies a reprieve, but the credit cycle has certainly rolled over. Defaults and downgrades are continuing to rise... The credit problems aren't going away. They're going to get worse.

But Porter isn't the only Stansberry Research analyst warning about the risk in high-yield debt...

This morning, our colleague Brett Eversole – senior analyst for Steve Sjuggerud's True Wealth advisory – also warned readers that a crash in junk bonds is approaching. As he wrote in today's edition of our free DailyWealth e-letter...

If you're a junk-bond investor, I have a message for you.

Get out.

The easy money in high-yield bonds is gone. Prices have soared. And the overall high-yield bond market sits at dangerous levels today. History says this setup could lead to double-digit losses. And that's why the smart move is to get out – now.

Like us, he noted that junk bonds have soared since last year's panic. The iShares iBoxx High Yield Corporate Bond Fund (HYG) is up 16% from its February 2016 bottom. And this big rally has pushed yields back to near-record lows... meaning junk bonds are riskier than ever. More from Brett...

In exchange for taking on more risk, investors are supposed to get the benefit of higher yields... But right now, that benefit hardly exists. High-yield bonds pay less than 6% today. That's one of the lowest yields we've seen over the last decade. This makes owning junk bonds a scary idea.

But the overall yield isn't even the best way to see what's happening. You can do better by looking at the junk bond "spread." By "spread," I mean the difference between the yield on high-yield bonds and the yield on similar-duration government bonds. For example, if high-yield bonds pay 6% and government bonds pay 2%, then the spread is 4%.

A high spread means high-yield bonds are a good deal. You'll earn a lot of income to compensate for the extra risk. But a low spread means high-yield bonds are a bad value – and much riskier.

High-yield bond spreads recently hit a multiyear low. Take a look...

As you can see in the chart, high-yield bond spreads have only been this low two other times in the past decade. And as Brett explained, both were terrible times to be a junk-bond investor...

Spreads were below 4% in mid-2007. That was just before the "Great Recession," which kicked off a massive 30%-plus decline in the high-yield market. We saw spreads bottom below 4% in 2014 as well. And high-yield bonds went on to fall by roughly 20% in the next year and a half.

Today, spreads are low again... at just 4.1%, as I write. And they've been below 4% for most of 2017.

This is a dangerous warning sign for high-yield bond investors. There's simply no margin for error with yields this low. And history says that major busts tend to begin when the spread hits current levels.

I can't know the exact timing... But even if I'm early, the message is correct. If you own high-yield bonds, get out – now.

But investors aren't just piling into risky corporate bonds today...

They're buying record amounts of risky corporate loans, too. As Bloomberg reported on Tuesday (emphasis added)...

If yield is a drug, Wall Street's working overtime to supply it. Investors' global reach for income is giving America's largest banks their biggest surge in risky-loan sales on record...

"There's a narcotic need for higher yield by debt investors, and the Street is going to create the deals to satisfy that," said David Hendler, founder of Viola Risk Advisors...

Banks arranged about $434 billion of leveraged loans in the first three months of the year, the most for a quarter in records going back to at least 1999, according to data compiled by Bloomberg.

If you're not familiar, leveraged loans are loans that banks make to companies – typically those with "junk" rated credit – and then sell to investors.

They're generally considered less risky than junk bonds. This is because they're "secured," or backed by some type of collateral, unlike most high-yield bonds. This means leveraged-loan investors are among the first in line to be repaid if the company defaults.

They also pay a floating interest rate – versus the fixed coupon of high-yield bonds – so they're less sensitive to interest-rate changes.

However, the leveraged-loan market tends to be a "last resort" of sorts. It's used mostly by companies that already carry large amounts of debt and are unable to tap the bond markets for more.

In other words, these are companies that are often too "junky" for even the junk-bond market... And they're likely to be among the first to default when the credit cycle finally rolls over. Being first in line to be repaid may not be the consolation many of these investors expect.

The financial media is now warning of a "nightmare scenario" in France...

As you may know, France will hold the first round of its presidential election this Sunday.

And polls are now showing not one, but two anti-European Union (EU) candidates could potentially reach the second round of elections next month. As financial-news site MarketWatch reported this morning...

Usually a French general election doesn't present a make-it or break-it moment for the entire eurozone, but this time it's different. After a race full of surprises, a surge in the polls by far-left, euroskeptic Jean-Luc Mélenchon has again reminded investors of the sweeping antiestablishment sentiment grabbing Europe and the U.S. at the moment.

Far-right, anti-EU candidate Marine Le Pen is also doing well in the polls and currently looks like she'll get one of the two spots in the runoff. The big question is who she'll face in the second round...

"Investors (and French voters) are getting worried about a 'nightmare' scenario in which Le Pen faces Mélenchon on 7 May, leaving them with a hard choice between two anti-globalization, anti-EU and pro-Russia candidates," strategists at Citigroup said in a note. "The French election presents 'volcano' risk, i.e. strong moves are likely across financial markets but risks are very much two-way," they added.

Analysts are predicting declines of anywhere from 5%-35% in European equities should either of these two candidates ultimately win the presidency in May.

That's possible... Of course, we heard similar warnings before the "Brexit" vote in June and Donald Trump's victory in November. Yet both were followed by big market rallies. The reality is, we simply don't know. If you own European equities, be prepared for volatility and consider tightening your stop losses.

One bet we would be willing to make: A win by either candidate would be bad for the euro. Gold and the U.S. dollar would likely do well.

Finally, a quick reminder...

Our colleagues at the Palm Beach Research Group are holding a free "cryptocurrency" training event tonight at 8 p.m. Eastern time.

If you've ever considered speculating in Bitcoin or one of its lesser-known competitors – or if you're simply interested in learning more about digital currencies – you owe it to yourself to check it out.

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(We also hear tonight's attendees will have the chance to claim an actual stake in Bitcoin, as part of a $250,000 "Bitcoin giveaway.")

Again, it's absolutely free to attend. Simply click here to sign up before 8 p.m. Eastern time.

New 52-week highs (as of 4/19/17): Chipotle Mexican Grill (CMG), Digital Realty Trust (DLR), National Beverage (FIZZ), Cedar Fair (FUN), JD.com (JD), and McDonald's (MCD).

In today's mailbag, a note from "oil country"... criticism for P.J. O'Rourke... and sour grapes about The Atlas 400. Send your notes to feedback@stansberryresearch.com. Good or bad, we read them all. And be sure to read on for the second installment of P.J.'s series on tax cuts.

"Thought you guys might like some feedback from oil country. I live 3 miles north of a railroad off load facility for pipe [in Oklahoma]. Until 30-45 days ago, it was a ghost facility. Today it is full of pipe and the trucks are moving. Not like the boom, when the trucks were running all day every day, but the trucks and pipe are moving." – Paid-up subscriber Clark C.

"Dear Mr. O'Rourke, we spend over 50% of our tax revenue on the military. That is a ridiculous amount of money, more than the expenditures of the seven next most insane nations in the world. We can easily cut 20% of that budget and still dominate the world in any reasonable manner and drop bombs wherever we want. That 20% cut would fund everything else the public needs, wants, and has the legal process to ask for – education, health care, food safety, clean air and water, tax cuts, tax reform, and on and on. Republicans are totally in charge right now and they can do whatever they want. They choose to increase the grossly bloated military budget. So until Republicans substantially cut the military budget, their moanings, groanings, and BS ideological positions about the costs of government are just a load of hot gas. Get on board reality, please." – Paid-up subscriber John Duggar

P.J. O'Rourke comment: Dear Mr. Duggar, I take your point about U.S. military spending being high. I hear from many sources (including sources in the military itself) about wasteful programs, exorbitant procurement prices, and weapons systems of dubious utility.

However, the "over 50%" figure that you cite is the percentage of discretionary spending that goes to the military. In fact, we don't spend anywhere near 50% of our tax revenue on our military. U.S. federal tax revenue is about $6 trillion, while U.S. military spending is currently about $6 billion. Only approximately 10% of our tax revenue goes to defense. And in return for that 10%, we get... America's armed forces. I've spent a lot of time with them around the world, and they are the best people anywhere, and, thank God, the best-trained and the best-equipped.

I don't know that I'd be in favor of lower military spending. But I would like to see some of that money taken away from Pentagon boondoggles and transferred to higher pay for members of the armed forces, especially for enlisted men and women.

"If I could afford your 30k enrollment fee in The Atlas 400 club, why would I need a club such as yours to lead me by the nose on excursions, etc? I would never feel comfortable in the company of snobs. And I view Porter and in all likelyhood, the club's member as such. And besides, as Grouch once remarked, "I would never join a club..." – Paid-up subscriber Joe N.

Porter comment: Maybe if you could join, you'd understand. Money doesn't change any of the basic human needs or interests... love, friendship, companionship, empathy, shared adventure. It just makes it a lot harder to find them.

When you're wealthy, all most people can see when they look at you are dollar signs. They either want your money or they want you to provide a means to get them... Or they're so jealous, they think and say terrible things about you without any basis (like calling you a snob when you've never met and they don't know a single thing about you, your struggles, your family, or your values).

Meanwhile... When I attend Atlas events, nobody cares. First, they already have as much or 100 times more money than I do. And so they already know it doesn't mean squat about who you are as a person.

P.S. It's sad to me that you think having wealth makes you snobby. In my experience, the wealthiest guy in the room is the person you'd guess last.

There's not a single snob in our group. We are a group of self-made folks who generally don't want to join the local country club.

We've all long since figured out the snobs are just folks who can't actually afford their lifestyle. The guys who can don't care to show it.

That's Atlas. We are just a bunch of folks having a great time together. As equals and friends. Nothing more, nothing less.

Regards,

Justin Brill
Baltimore, Maryland
April 20, 2017

Editor's note: Yesterday, we shared the first part of a two-part series from Digest contributing editor P.J. O'Rourke. In it, he looked at the hurdles we face in reforming the U.S. tax code. In today's conclusion, P.J. discusses the different ways to tax people... and explains which type of levy would help the U.S. balance its budget once and for all...

The Tax Reform We Need and Want, Part II – There Is Hope

By P.J. O'Rourke

As I said yesterday... we really need tax reform, and we really want tax cuts.

But... in order to have a balanced budget, we also really need at least $3.6 trillion in federal government revenue.

Can it be done? I say it can. But how?

First, let's take a look at the tax system we have. And a look is all that's required to see that we have to get rid of it. The federal tax code is 4 million words long – five times the length of the Bible. You can swear on the Bible. You can only swear at the federal tax code.

So we need a different process for collecting government revenue.

There are only a certain number of ways to tax people.

The simplest levy is a "head tax." Everyone is charged an equal fee. This has ancient precedents. The Roman Empire placed a head tax on its subject peoples. Mary and Joseph were on their way to Bethlehem to be counted – and hence taxed.

This would lead to some problems for the Roman Empire, such as Christians who would rather be eaten by lions than bow down to it.

A head tax would also lead to some problems for America. There are 319 million people in the U.S. In order to get $3.6 trillion, we'd have to charge them $11,285 each – a good deal for people in the upper tax brackets. A family of three would only pay the IRS $33,855 – less than the tuition for keeping its rich kid in his seventh undergraduate year at Brown.

Ooooh, but for a family of three with the U.S. median household income of about $52,000... Not such a good deal.

A $33,855 tax bill would put them below the poverty line, and the federal budget would go berserk because we would be paying welfare benefits to half the nation.

As for people who are truly poor, it would take quite a shakedown racket to extract nearly $12,000 apiece from them. We'd have to scrap the IRS, get all the old mafia guys out of the witness protection program, and put them back to work as strong-arm debt collectors.

Meanwhile, let's just forget about corporate income taxes. The U.S. corporate tax rate is 35%, which makes us about as competitive in the global business world as the one-win Cleveland Browns were in the NFL last year.

And why should we tax corporations at all when we tax the investors who profit from corporate dividends? This is like giving your child an ice cream cone, but taking a bite out of it first and then, when she begins to cry, taking a larger bite.

Besides, as high as corporate taxes are, they bring in only $300 billion a year to the U.S. Treasury.

Next, there's a consumption tax, or "value-added tax" (VAT). You can think of this like a state's sales tax. For a VAT to raise $3.6 trillion, it would have to be applied to the entire U.S. GDP of $18.6 trillion at a rate of about 19% on every good or service you purchase.

Except the situation is worse than that... We devote 13.2% of our GDP to mandatory government entitlement spending. We're not about to take nearly one-fifth of impoverished old peoples' Social Security checks or charge wounded veterans a 19% tax on their wheelchairs. This leaves us with an approximately $15 trillion GDP requiring a VAT of almost 25%.

That will be inflationary.

Or we could fund the U.S. federal government the way it was traditionally funded in the 18th and 19th centuries – with import taxes. U.S. customs duties currently average 3%. Our annual imports are valued at about $2.8 trillion. In order to get the $3.6 trillion we want, we'd have to impose an across-the-board tariff of nearly 130%.

Of course, this would set off a trade war. (Although, I've always sort of liked the idea of a trade war, at least as opposed to a real war. The French would throw bottles of wine at us, and we'd heave big chunks of Velveeta at them.)

Another traditional method of extracting cash from a nation's citizens is a property tax levied on net worth. The Federal Reserve estimates the full U.S. total net worth to be $86.8 trillion. A 4% tax on all our property would suffice.

Average Americans will be pleased. U.S. median net worth is $44,900. A tax bill of $1,796, including all payroll and social insurance charges, is a bargain.

But too bad about Mom and Dad who paid off their mortgage and stayed in the shabby old neighborhood... which has now gentrified and made their house worth $1 million. They'll be paying $40,000 a year plus $200 for the $5,000 they have left in their IRAs.

A flat tax, with absolutely no deductions, seems nearly as simple as a head tax. According to the Fed, total U.S. annual personal income is about $16 trillion. We could get our $3.6 trillion with a 22% flat tax.

This still clobbers the poor and the middle class, even if it looks good to people making more than $100,000 and currently paying marginal tax rates of between 28% and 39.6%.

Except, like a lot of things that look good, it doesn't look quite as good if you look closer. American democracy would never let us get away with applying a 22% income tax without any deductions to the majority of people who can vote.

And high-income Americans aren't the majority. Americans with an adjusted gross income of more than $100,000 file only 16% of income tax returns, while paying nearly 80% of all income tax.

Using a rough estimate based on those income-tax returns, high-income Americans account for about $13.2 trillion of the nation's roughly $16 trillion in personal income.

To push a flat tax through congress, the flat tax would have to be applied almost exclusively to the $13.2 trillion earned by high-income Americans. This means a 27% flat tax rate.

It's better than 28% to 39.6%. Or not. The nonpartisan Pew Research Center calculates that people who make $250,000 a year or more, in fact, pay an average income tax rate – after deductions, capital gains allowances, etc. – of 25.7%.

Still, a flat tax brings us closer to what we need and want than any other type of taxation. Let's fiddle around the other taxation methods and see if we can get that flat tax down a little...

Surely it's worth $1,000 a year to live in the United States. That's only $83.33 a month. We're talking the price of cable TV. And what could be more American than watching television?... A head tax brings in $319 billion.

A national VAT does violate the "Don't Feed the Beast Rule." We should never, ever let the government invent a new tax. It will never go away, and all other taxes will remain in place at equal or higher rates. But that's in the real world. We're dreaming here. A consumption tax of 5% won't break the bank... VAT brings in $750 billion.

We raise customs duties to 10%. That's not prohibitive. And if the French want to throw a bottle of wine at me, make that a 2009 Château Lafite Rothschild... Tariffs bring in $280 billion.

A 0.5% net-worth tax finally convinces Mom and Dad to sell out, get away from the noisy hipsters, and move to Sarasota... Property tax brings in $434 billion.

Let's add it up...

We only have $1.783 trillion to go to reach $3.6 trillion. And we can get that with a 14% flat tax on high-income earners.

Now – as soon as Americans vote me in as president, elect me to every seat in the House of Representatives and the Senate, and appoint me to the Supreme Court so that it has an extra-conservative majority to quash any lawsuits against the above proposals – we'll have the tax reform we need and want.

Regards,

P.J. O'Rourke

Editor's note: If President Trump's tax-reform proposal passes, all of the power that has been consolidated in D.C. over the past 40 years will evaporate. In essence, Trump has put a metaphorical gun to the head of the "Deep State." And now, the Deep State is fighting back...

Porter and his team of analysts have put together a list of 12 companies that stand to win and lose based on Trump's proposals. If they're right, you could pocket gains like 1,110%... 1,370%... 2,650%... 4,980%... 6,760%... and more. But you have to act quickly because as soon as these laws go into effect, the opportunities won't last long. Click here to learn more.