Introducing the Trade of the Year

Stocks dive again... 'Buy bonds, wear diamonds'... Introducing the trade of the year... Two factors that will push bond yields even lower in 2020... The river of stimulus is already flowing... Don't make this 'vanity trade'... An easy way to play this opportunity...

The major U.S. stock indexes plunged for a second straight day...

The spread of the coronavirus to new pockets of the globe has spooked investors – and we're not going to say the nerves are for no good reason.

Just this afternoon, the U.S. Centers for Disease Control and Prevention ("CDC") warned that it's not a matter of if the virus upends Americans' daily lives... but when.

"This might be bad," Dr. Nancy Messonnier, director of the CDC's National Center for Immunization and Respiratory Diseases, told reporters earlier today.

The major U.S. stock indexes responded in kind, each finishing the day down about 3%.

Nobody really knows how long this wave of fear will grip the markets... but fortunately, we don't need to guess. In today's Digest, I (Dan Ferris) will share an alternative investment to make for this entire year.

And, no, it's not "short stocks." I'll explain all the details below. (And let me note that I began writing about this idea before the week started... and the markets started falling.)

'Buy bonds, wear diamonds'...

This Wall Street adage from the 1980s and early 1990s means exactly what it sounds like... If you invest in bonds, you'll likely become rich enough to wear diamonds.

It rings true... Long-term U.S. Treasury bond yields peaked in 1981 at around 15%. (And that means their prices bottomed, since bond yields move inversely from bond prices.)

So if you bought government bonds at almost any point in the early 1980s... you earned fat, double-digit yields in addition to substantial capital gains. By 1990, long-term Treasurys yielded roughly 8%, meaning investors who bought in 1981 and held for nine years earned 15% per year in interest payments... and also made more than 80% in capital gains.

You could buy a lot of diamonds with those types of returns.

Bond yields are much lower today... The yield on the 30-year U.S. Treasury bond is currently around 1.85%. That's a record-low yield for these long-term bonds.

But that doesn't mean these yields can't go even lower...

Today I'll detail why bond yields are set up to move lower – meaning bond prices will move higher – due to a couple of factors. As I'll explain, this might be the trade of the year for 2020... It's some of the easiest money you'll ever make.

I got this idea while chatting recently with global macro trader Raoul Pal...

Pal worked as a hedge-fund manager – including at financial giant Goldman Sachs (GS) in London – before retiring at age 36 in 2004. Longtime Digest readers might also recognize him as the co-founder of the Real Vision media group with our friend Grant Williams.

On the Stansberry Investor Hour podcast earlier this month, Pal invoked the saying as he detailed one of his favorite trades... In short, he's focused on buying U.S. Treasury bonds and "eurodollars" – a fancy word for U.S. dollar-denominated deposits at foreign banks.

It's really just a play on falling LIBOR interest rates. LIBOR – short for the London Interbank Offered Rate – is an important global benchmark of corporate borrowing costs. It's the rate at which major global banks are willing to lend money to each other over short periods of time.

Pal expects LIBOR rates will move lower from here. And in turn, bond investors in the U.S. and abroad will see higher prices.

According to Pal, the story starts with the business cycle – and more specifically, manufacturing data...

The Institute for Supply Management ("ISM") began compiling these data several decades ago. A reading of more than 50 indicates a period of expansion in the manufacturing part of the U.S. economy, while a reading of less than 50 signifies contraction.

During our Investor Hour discussion, Pal explained why he uses the ISM manufacturing data to track the business cycle...

It basically surveys a bunch of buyers within the largest companies in America and asks them about financial conditions, market conditions, their inventories, their expectations for the future. And it blends it all together and gives you an indicator that's been going essentially one way, shape, or form – it was the Treasury survey before that – since about 1910 or something... 1917.

So there's a huge amount of data... And what's interesting [that] I found about it is, all asset prices are correlated. Basically, the year-on-year change in the S&P [500], bond yields, copper, emerging markets... everything is related to the business cycle.

In other words... it's a widely followed, reliable indicator of U.S. economic activity.

During the interview, Pal echoed a sentiment that might sound familiar to regular readers...

He explained that the ISM sits at about 50 today – near the traditional dividing line between expansion and contraction. And more important, it peaked at roughly 60 in August 2018...

Based on that data, he believes the current business cycle has peaked. According to Pal, it tells us that the next recession is coming. It's just a matter of when everything unfolds.

If you read the January 14 Digest, you know Stansberry NewsWire editor C. Scott Garliss explained that the ISM's data can give us an idea about the timing, too. As Scott wrote...

Since [1950], the average amount of time from the index's peak to recession is 31.5 months... This tells us a recession is likely around March 2021.

It remains to be seen whether this economic cycle will follow that roadmap. Pal expects a recession to begin later this year. But no matter when it actually arrives, one thing is clear... With U.S. manufacturing numbers down, it's harder to ignore other global concerns.

Consider the 'coronavirus crisis' sweeping across the world, for example...

As you know by now, a previously unknown strain of coronavirus – known as the "Wuhan virus" or "COVID-19" – was first detected in China at the end of 2019. It soon spread outside the country. And the number of people infected worldwide keeps growing...

As we go to press, more than 80,000 people have been infected. That includes more than 2,400 confirmed cases in at least 35 countries and territories outside mainland China. And at least 2,700 deaths – mostly in China – have been attributed to the virus.

According to the CDC, the U.S. has 57 confirmed cases of the virus. That includes 14 cases among people inside the country and 43 Americans evacuated from the city of Wuhan, where the virus originated, and a cruise ship stranded in Japan. The CDC has tested more than 425 people since January 21.

We can't know for sure when the virus will stop spreading. And the thing is, it might already be too late anyway. According to Pal, the biggest damage to the Chinese economy is already done...

So how people react to something like this is, China goes into massive lockdown, because they know it's bigger than they're reporting. And it's huge. So you basically shut down all economic activity in China, which is truly astonishing.

But again, it's not China necessarily. It's what everybody else looks at. They see how China is reacting so strongly and they know they have only one chance to react – and they better overreact.

And the overreaction is shutting down all flights to China, stopping imports of people. Kids in [Hong Kong] are not going back to school till mid-March. People are shutting down borders with China. Russia has. Hong Kong [is shutting down some of] its [borders] with China. You know, we see the U.S. banned people coming from China.

This is a huge thing.

He's right. Just look at air traffic over China...

According to the World Bank's 2018 figures, China makes up roughly 14% of global air traffic (measured by passengers flown). But it hasn't been that way recently...

If you look at the current map on global flight-tracking website Flightradar24, the skies over normally hectic eastern China aren't nearly as crowded as Japan and India. Flightradar24 noted on February 14 that air traffic at China's busiest airports was down 80% in 2020.

China is suddenly using a lot less electricity, too... According to the Financial Times, Goldman Sachs recently reported that the amount of coal used by the country's large electricity producers was a third lower than normal in the first 16 days of February.

Given that travel and power consumption are such important economic indicators, it's likely that the Chinese economy is more depressed than anyone currently understands.

When you factor in all the companies doing business in China, it's much worse...

My colleague Corey McLaughlin talked about this aspect in the February 20 Digest. He explained that many companies are already preparing for earnings misses. As he wrote...

The story is becoming a major narrative in companies' conference calls with analysts... In a Google Trends-type indicator, 38% of earnings calls from January 1 through February 13 included the term "coronavirus" at least once, according to market-research firm FactSet.

At the start of this week, tech giant Apple (AAPL), which has major iPhone production facilities in the Chinese province that's ground zero for the virus outbreak, said it would probably miss second-quarter expectations... 15% of its business comes from China.

Just today, Air France said the impact of the virus will be "brutal" for the airline... consumer-goods company Procter & Gamble (PG) is dealing with supply chain issues... and Norwegian Cruise Line (NCLH) canceled Asian trips through the third quarter of 2020.

To me, the most noteworthy tidbit comes from Apple... It became the first major U.S. company to report that it would miss its quarterly revenue projections due to the virus.

The iPhone accounts for more than half of the company's revenue. Initially, Apple predicted $63 billion to $67 billion in revenue for the current quarter (an already wide range, due to virus concerns). It didn't issue any updated expectations while warning about the expected miss. It's only the second time in Apple's history that it has missed revenue guidance.

And yesterday, the bad news continued for major corporations with connections to China...

United Airlines (UAL) withdrew its full-year earnings forecast for 2020 – which it had issued in late January – citing the ongoing effects of the coronavirus on its business. The airline has suspended flights between the U.S. and cities in China and Hong Kong through April 24.

Mastercard (MA) also cut its forecast for quarterly revenue growth after the markets closed yesterday. As the credit-card company explained in a statement...

Cross-border travel, and to a lesser extent cross-border e-commerce growth, is being impacted. There are many unknowns as to the duration and severity of the situation and we are closely monitoring it.

This is a big deal.

Of course, as Corey noted in the February 20 Digest, central bankers from China and other countries aren't sitting on their hands. They'll do whatever they can to keep the party going.

That means massive amounts of monetary and fiscal stimulus for the global economy – including a substantial reduction in interest rates around the world. And remember, lower interest rates mean bond prices – especially U.S. Treasurys – will be much higher.

The river of stimulus is already flowing...

On Thursday, Corey detailed the recent moves from the People's Bank of China ("PBOC") and other central banks to combat the economic impacts of the coronavirus. As he wrote...

This week, the PBOC cut its benchmark one-year loan prime rate – which is used to set rates for mortgages and other lending – from 4.15% to 4.05%... The PBOC hopes the change helps move money around its economy.

The bank also cut its five-year rate from 4.8% to 4.75% and lowered its "medium-term lending facility" by one-tenth of a percentage point. This move makes lending between banks cheaper.

A day earlier, in the February 19 Digest, my colleague and True Wealth analyst Chris Igou explained that Japan is continuing its massive stimulus efforts, too. From that Digest...

Japanese Prime Minister Shinzo Abe's latest efforts started in December – before anyone knew what the coronavirus was – with a stimulus package to mitigate any risk associated with the 2020 Tokyo Olympics. Now, Bank of Japan officials say they won't hesitate to enact similar policy if they feel the spread of the coronavirus hurts growth in the country.

Meanwhile, Singapore's economy is highly dependent on China. Its government recently enacted a $4.6 billion financial stimulus package, including corporate income tax rebates and support for hard-hit sectors like tourism, retail, and aviation.

Nearby, Malaysia is putting the same amount ($4.6 billion) into its stock market. And South Korean President Moon Jae-in says "emergency steps" are needed to fight the impact of the virus. He wants to see "all possible measures" used to buttress his country's economy.

And here in the U.S., Pal believes we'll soon see similar efforts from the Federal Reserve...

The benchmark "federal funds rate" – the overnight rate at which banks lend reserves to one another – currently sits at 1.75%. But Pal thinks the Fed will target cuts of 100 basis points (a full percentage point) from here. And he thinks it could happen as early as June.

It might not happen that quickly, but it's clear that folks expect the Fed to cut rates...

Global markets company CME Group's "FedWatch Tool" measures the bets that traders are placing. And right now, it indicates a roughly 75% chance of at least one rate cut by June.

Since he's so adamant that the next recession is imminent, I asked why Pal doesn't want to short equities...

Pal warned against it, calling it a "vanity trade." By that, he simply means it's a risky trade designed more to make the trader look smart than to make money while minimizing risk. As he explained during our interview...

I found that the reaction function of the Federal Reserve says that if growth slows, they will cut rates. Therefore, own bonds. So that's an easy trade.

People tend to get confused and want to do a "vanity trade," as I call it, which is short equities. Now, short equities... they come with much higher volatility.

They don't look like a call option, which is what... the short end of the bond market looks like... They're unlikely to raise rates, but there is a high probability they cut rates. And therefore, it looks like a call. It's a one-sided risk-reward. Equities aren't.

In other words, shorting equities comes with potential downside that you don't get with bonds... The stock market could keep moving higher, causing you to lose a ton of money.

But with bonds, there's plenty of upside potential... with far less downside risk. The Fed isn't likely to raise rates anytime soon.

That's what Pal means when he says it looks like a call option. It's simple and smart.

Successful investors find trades that go straight to the heart of their thesis...

In this case, economic weakness and central bank intervention is our thesis. So the direct play must be in bonds... because that's the most direct way to play interest rate moves.

Pal also pointed out that equities generally tend to be least sensitive to macroeconomic developments like the one he recommends playing in bonds today. Bonds – especially short-term bonds – tend to be the pure play and the most macro-sensitive asset class.

The insight about equities being the least macro-sensitive asset class is funny, isn't it?

Day after day, we see the equity markets reacting to every kind of macro data known to man... housing numbers, unemployment, Fed policy, inflation reports, all kinds of business and consumer surveys about the state of the economy... and so on. And yet, as Pal pointed out, equities tend to be the least-sensitive asset class to macro developments.

That's just another way of saying that shorting the stock market isn't the best way to trade Pal's idea... that a depressed ISM combined with the current coronavirus fears will lead to global economic weakness, and in turn, lower bond yields (higher bond prices).

You shouldn't short equities for this trade because it's not based on a bottom-up idea about individual businesses... It's based on a top-down idea about the global economy.

This observation also tells me that maybe folks should own fewer stocks and more bonds...

Or they should at least stop worrying about the big picture so much... and instead, start worrying about owning the kinds of businesses that minimize worrying altogether.

We've done a little bit of both in my Extreme Value service... My research analyst Mike Barrett and I look for stocks that we expect to do very well even if – and when – the next recession hits. And in December, we recommended a play on short-term bonds.

In our write-up on short-term U.S. Treasurys, I said that we don't expect big gains. But Pal's discussion of the call-option-like aspect of short-term bonds made me wonder...

Let's say you have a short-term bond position that yields around 2% right now.

What if we experience an unexpected, severe shock to the stock market? It would likely send folks running into bonds... especially cash-like, short-term instruments.

And what if that 2% yield quickly dropped to a 1.5% yield? That would be a quick 33% return on investment from one of the safest assets you can own – short-term Treasurys.

That's your call option... limited downside (if any) with explosive upside potential.

"Buy bonds, wear diamonds."

As central bankers fight global economic contagion aggravated by the viral contagion raging in China and other countries, it'll likely be a profitable trade for the next four to eight months. In fact, as I said earlier... it could easily be the trade of the year for 2020.

So what's the best way for everyday investors to play this opportunity?

"TLT is your friend," according to Pal.

By that, he's talking about the iShares 20+ Year Treasury Bond Fund (TLT). The exchange-traded fund ("ETF") holds U.S. Treasury bonds with maturity dates of 20 years and longer.

And TLT is proving to be a great "safe haven" for investors right now...

As the latest fears swept through the global markets yesterday and today, TLT gained more than 2%. So far in 2020, it's up more than 11%. And I believe it could easily rise another 20% or 30% by the end of the year.

New 52-week highs (as of 2/24/20): Sprott Physical Gold and Silver Trust (CEF), DB Gold Double Long ETN (DGP), Franco-Nevada (FNV), VanEck Vectors Gold Miners Fund (GDX), SPDR Gold Shares (GLD), Barrick Gold (GOLD), Lundin Gold (LUG.TO), NovaGold Resources (NG), Nuveen Municipal Value Fund (NUV), Pan American Silver (PAAS), Polymetal International (POLY.L), Sandstorm Gold (SAND), iShares 1-3 Year Treasury Bond Fund (SHY), Torex Gold Resources (TORXF), ProShares Ultra 20+ Year Treasury Fund (UBT), and Wheaton Precious Metals (WPM).

In today's mailbag, one subscriber shares his perspective and offers a solution to fix the U.S. health care system. Our colleague Thomas Carroll addressed this topic in last Friday's Digest. As always, send your comments to feedback@stansberryresearch.com.

"The political noise about issues with health care confuse two distinctly different issues. We have a problem in this country with delivery of health care. Many areas, particularly rural areas, do not have access to services because the doctors, clinics, imaging centers, etc., are just not there to serve the people in the area. Doctors, hospitals and services can't succeed because there aren't enough people/consumers to support the providers. The cost of delivering health care is too high – the overhead is too much, so the businesses close or move elsewhere.

"The second problem is the cost of health care insurance and individual cost burdens. Costs in the USA are high, due to favoritism by politicians. Health insurance companies were granted an anti-trust exemption decades ago and they maximize it. They collude to set prices and minimize what they pay to providers.

"I have seen it personally. I made 30% more as a physical therapist in 1995 than I make now, but the business overhead has gone up dramatically since 1995. The current system is deeply flawed, but could be improved dramatically by implementing competition among pharmaceutical companies, revoking insurance anti-trust exemptions and creating more competition and less collusion.

"Medicare for All is not a solution, it's a government takeover of 18% of the GDP and further concentration of power to the federal government. Get the U.S. out of funding pharmaceutical R&D. If the drug is cheaper overseas, import it. Create competition by revoking collusion and price-fixing. Incentivize providers to work in underserved areas. But keep the financing problems clearly separate from the delivery problems and quit mixing the two issues together." – Paid-up subscriber Don S.

Good investing,

Dan Ferris
Vancouver, Washington
February 25, 2020