Editor's note: When the "yield curve" inverts, it will lead to a financial horror show...

It will cause banks to suddenly cut off credit to the most heavily indebted companies – so-called "zombie companies." Companies that rely on banks to refinance their debt will suddenly get cut off and go bankrupt, triggering the next crisis.

The good news is, you don't have to be a victim when that happens. You can actually make a killing during a credit crisis by buying an investment most people never consider – corporate bonds. But you have to know the right kinds of opportunities to look for...

In today's Masters Series, we're sharing an essay from Porter and the Stansberry's Credit Opportunities team that's adapted from the January 2016 issue. In it, they explain why you must think beyond the "first level" to find the best opportunities...

Mastering the 'Second Level' Is Key for Your Investment Success

By Porter Stansberry and the Stansberry's Credit Opportunities team

Howard Marks is extremely good at being in the right place at the right time...

Marks is probably the world's greatest distressed-debt investor. He buys the debt of companies when it trades for pennies on the dollar... then profits when the companies are able to pay off the debt.

In 1988, Marks started the world's first institutional distressed-debt fund. Today, he runs Oaktree Capital (OAK) – an alternative asset-management firm he founded in 1995. Oaktree manages nearly $120 billion for its clients, with most invested in distressed debt.

After fees, Marks' distressed-debt funds have returned 16% annually for about three decades. The key to Marks' success is understanding market cycles. His timing has been impeccable.

In March 2008, for example, Marks raised more than $10 billion to invest in distressed debt. Up to that point, it was the largest distressed-debt fund ever. About a year earlier, Marks had written the following in one of his famous client memos...

Readers of my memos know that one thing I believe in most strongly – and harp on most frequently – is the inevitability of cycles. They're something we can depend on absolutely...

Investment markets make the same pendulum-like swing:

• between euphoria and depression,

• between celebrating positive developments and obsessing over negatives, and thus

• between overpriced and underpriced.

This oscillation is one of the most dependable features of the investment world, and investor psychology seems to spend much more time at the extremes than it does at the "happy medium."

On September 15, 2008, the pendulum swung.

Just six months after Marks began amassing his war chest... the investment bank Lehman Brothers collapsed, and took down the debt and equity markets with it.

From mid-September to the end of 2008, Marks deployed around $75 million a day... gobbling up the best assets for pennies on the dollar. By New Year's Day 2009, he had invested more than 70% of his $10 billion fund.

We watch Marks closely. We read his client memos. And we're not alone... "When I see memos from Howard Marks in my mail," billionaire investor Warren Buffett once gushed, "they're the first thing I open and read."

Marks attributes much of his success to what he calls "second level" thinking. As he points out to his clients, that means in order to outperform the market, you must behave, react, and think better than others.

Most people are first-level thinkers. They behave in typical ways, so their investment performance is average.

Marks points out that first-level thinking is simplistic and superficial, and just about everyone can do it... "All the first-level thinker needs is an opinion about the future, as in, 'The outlook for the company is favorable, meaning the stock will go up.'"

In contrast, second-level thinking, Marks warns, is deep, complex, and convoluted...

"What is the range of likely future outcomes?"... "Which outcome do I think will occur?"... "What's the probability I'm right?"... "What does the consensus think?"... "How does my expectation differ from the consensus?"... These are the kinds of questions the second-level thinker asks.

The bottom line is that first-level thinkers see what's on the surface, react to it simplistically, and buy or sell on the basis of their reactions... In contrast, second-level thinkers double-think (and triple-think) every angle of every situation.

It sounds obvious, but of course, it's easier said than done.

First-level thinking is easy. But as super-investor Charlie Munger – Warren Buffett's business partner at Berkshire Hathaway – once told Marks: "[Investing is] not supposed to be easy. Anyone who finds it easy is stupid."

It's human nature to "go with your gut"... But as Marks has shown over his career, you always need to second-guess yourself.

In early 2016, in our corporate bond newsletter, Stansberry's Credit Opportunities, our bond screening and scoring model flagged two "outliers" – bonds priced much lower than what we'd expect given the level of safety that they offer.

One came from a company we loved. The other company had lousy prospects. We once told some of our Stansberry Research subscribers to steer clear of the stock at all costs.

The easy choice would have been to buy the bond from the company we loved. But as Marks knows, second-level thinking reveals that loving a company is not the same as loving its bond.

The company we loved was pivotal in the development of "cloud computing." If you're unfamiliar with cloud computing, it's simply the move by businesses around the world to replace on-premises hardware and software with systems that are housed by a third party and accessed over the Internet.

At the time of our analysis in early 2016, the company we loved generated about $25 billion in annual sales with gross margins of around 60% and operating margins of 13%. Its sales were slowing, but it was still projected to grow around 4% that year.

The company generated a lot of cash... between $4 billion and $6 billion per year in free cash flow. (That's how much cash is left after all operating and capital expenses are paid.)

And its balance sheet was a fortress. It had $45 billion in assets, including $7.6 billion in cash on hand. With a total of only $7.5 billion in debt, the company could've cut a check the next day to pay off all its debt... with plenty of assets to spare.

That seemed to make its bonds a virtually no-risk proposition.

Our proprietary Stansberry credit-rating system gave the bond we investigated a super-safe "9" (one notch below our highest rating). Credit-ratings agency Standard & Poor's rated it as an "A" and credit-ratings agency Moody's rated it as "A1" – solidly investment-grade.

The bond was trading with a yield to maturity ("YTM") of 5.7%. Bonds with similar ratings typically were yielding 1.75%.

A super-safe bond yielding almost an extra 4% looked like a real coup. And it would have diversified our portfolio with a lower-risk bond. That was our first-level thinking. We loved the company, and its bond looked great... Recommending it would've been the easy choice.

But in late 2015, the company was taken over by a computer maker. The computer maker raised a reported $50 billion in additional debt to fund the deal. And importantly, all of it would end up having priority in the capital structure over the bond we were investigating.

In short, if something were to go wrong and the company's loans defaulted, bondholders in the new entity would have been standing in the front of the line. Meanwhile, existing bondholders – which would've included us – would have been left with little or no recovery.

Using only first-level thinking, we loved the bond. Its YTM was three times greater than the other companies with its safety rating. By that measure, it was the single biggest outlier in our monitor – bar none. And the fact is, we doubted these bonds would default. Remember, the company was generating at least $4 billion per year in free cash flow.

Regardless, our second-level thinking moved us to the sidelines...

This bond carried more risk than it appeared on the surface. In the unlikely event of default, it would've been pushed too far down the debt-recovery ladder.

On the other hand, that same kind of second-level thinking uncovered a great opportunity that month to buy the bond of a lousy company... a 4% bond due in February 2018.

The bond traded at around $800 with a YTM of 16%. It was the only bond with a "Moderate" risk rating that yielded greater than single digits at the time. The company owed $250 million on the bond, which was most of the company's $300 million in debt at the time.

The company was a biotech patent holder and provider of alternative financing to late-stage public and private health care companies. It licensed its patents to biotech companies that built drugs around them. At the time, it had just 10 employees whose job was to manage its patent assets and collect cash.

The company had huge profit margins, and its return on assets was one of the highest we've seen. But there was one huge problem...

Its main patents historically generated more than 90% of its revenue. But those patents were expiring, and the company could only collect royalties on these patents through March 2016.

However, this wasn't a surprise... The patents' expiration had been public knowledge for years. But the markets seemed to only realize it in early 2016. The bond price had fallen from a price of around $1,170 in June 2014 to around $800 by early 2016.

Its revenue was expected to total around $560 million in 2015, but it was expected to drop roughly 60% to around $227 million in 2016. It's never good when a company loses most of its revenue.

So when we first saw the bond as an outlier, we already knew we hated the stock. At first glance, we dismissed it as a possible recommendation. That was our first-level thinking.

However, second-level thinking revealed more to the story...

The company had enough cash to fund its operations for the next several years. And it owned other late-stage technologies it had been buying from other biotech firms since 2012 to replace its lost revenue. It had about 12 active royalty agreements at the time of our analysis.

These patents hadn't begun generating material amounts of cash flow yet. But these assets gave it the right to collect around $750 million in future royalties over the next eight to 10 years.

And based on our projections, the company would only need to collect around 14% of that cash over the next two years to pay off our bond in full. And even if it couldn't, the company still had other options to raise the cash needed to pay off the bond – including getting new bank loans.

In other words, we knew we would be paid. And as bondholders, that's all we care about.

Eventually, the markets saw things the way we did... Investors realized the bond was completely safe. The bond price returned to par value in May 2017... well before its maturity in February 2018.

When it did, we recommended that our Stansberry's Credit Opportunities subscribers sell the bond. Subscribers who took our advice realized a gain of 34% in less than 16 months. That's an annualized yield of around 25%, even better than the 16% yield we would have earned if we held it to maturity.

First-level thinking led us to a bond that yielded less than 6% and was much riskier than it appeared. Second-level thinking led us to a safe bond that yielded four times as much.

It's this second-level thinking that drives our results in Stansberry's Credit Opportunities...

Since launching the newsletter in November 2015, we've averaged an annual return of 21% with 20 closed positions. That's 2.5 times better than the overall "junk" bond market's return over the same period. We even beat the return of the stock market... The S&P 500 Index's weighted return during the same period is about 17%. And we did it while taking on far less risk.

So the next time you're looking at an investment, we encourage you to go beyond first-level thinking. By using second-level thinking, you'll ask yourself all the questions you need to succeed.

Regards,

Porter Stansberry and the Stansberry's Credit Opportunities team

Editor's note: Most folks just aren't familiar with bonds. They've never bought one, and they don't understand how the whole process works. The good news is... it isn't that hard.

To prove it, we recently handed the microphone over to a longtime subscriber. He revealed exactly how this strategy helped him retire at age 52. But that isn't all... As part of our deal, we've agreed to do something we've never done before. Watch his presentation right here.