Profiting from America's next 'debt trap'...

Profiting from America's next 'debt trap'... This unusual bear-market 'hedge' is paying off... More signs of trouble in the oil patch...

We wrote it... Did you short it?

Regular Digest readers know we've been warning of an impending crisis – the greatest legal transfer of wealth in history.

Porter has explained why some of the biggest problems will be centered on the energy sector, auto loans, and student loans. But those aren't the only concerns.

In the December issue of Stansberry's Investment Advisory, Porter and his team highlighted another looming "debt trap"...

The credit cycle is rather predictable. After a crisis, creditors tighten lending standards. Institutions only extend loans to the most creditworthy. But over time, these standards begin to loosen. Debt becomes much easier to obtain. The credit pool starts to expand. Eventually, excessive lending to people and institutions that aren't creditworthy results in large amounts of unpaid debt. And another credit crisis appears.

These cycles normally last about seven years... The last crash was in 2008, so we are on schedule for another. But this next one will be much larger than others before it. Thanks to government bailouts, cheap money, and enormous money-printing by the Federal Reserve, all of the bad debt from the prior crisis didn't get flushed from the system. The debts just got bigger... and pushed further out. A lot of that debt starts falling due over the next few years. We expect the magnitude of the crash will be much worse this time.

This month, we turn to the fourth-largest source of household debt behind mortgages, auto loans, and student loans. It is time to sell short... one of America's major credit-card lenders.

As they explained, credit-card companies are especially vulnerable during times of financial stress...

When things tighten up, people must decide which bills to pay. If you're paying a mortgage to put a roof over your family's head, you'll likely pay that first. And if you need your car to get to work and back, that loan probably comes next. We already know student loans don't rank high on the list. Credit cards also rank well down the list. And if you're paying hefty double-digit interest rates, you've probably not warmed to the idea of paying your credit-card company early... if at all.

When the credit crisis hits, we doubt much sympathy will go out to credit-card companies. Those with the most exposure can expect investors and depositors to flee.

Porter's team recommended shorting shares of one of the country's largest credit-card companies – Capital One Financial (COF) – to profit from this trend...

We've written about Capital One before, shorting it back in 2008 (twice) and again in 2011. Each time, we profited, with annualized gains of 53%, 16%, and 12%, holding each position for around 120 days. We think we could do even better this time.

Capital One's total loan book is around $213 billion today. More than $90 billion of it, 42% of the total, is unsecured credit-card debt. Here it lends to both prime and subprime borrowers. At the end of last year, about 32% of its credit-card borrowers had FICO scores of 660 or below. (660 and above is considered good credit.)

Another $67 billion of Capital One's loan book is auto loans and mortgages, with commercial loans comprising the balance. Its auto-loan division also lends to prime and subprime borrowers. Around 50% of its auto-loan borrowers have FICO scores below 660, and about 33% are 620 or below. The average loan term is 72 months.

Although Capital One does hold about $14 billion of subprime auto loans, its riskiest asset is the unsecured credit-card debt, accounting for 80% of its loan losses. When this credit-card debt starts to go bad, profits can quickly disappear. Over the next 12-18 months, that is exactly what we expect will happen.

The market appears to agree...

Shares of Capital One peaked near $80 the day of their recommendation and have been headed lower since. The stock just hit a fresh 52-week low today. As of yesterday's close, Stansberry's Investment Advisory subscribers were up 9% in just more than a month...

But Capital One isn't the only Stansberry Research short-sale recommendation hitting a new low this week. (Remember, when you sell a stock short, you want shares to go lower.)

Back in August – just before the benchmark S&P 500 Index plunged 10% – the DailyWealth Trader team recommended an unusual way to protect your portfolio against a potential bear market in stocks. From the August 20 issue of DailyWealth Trader...

Right now, one of the biggest worries among investors is the potential of a bear market in stocks... and how to handle it. People who have big stakes in the stock market wonder what they should do. Hold? Sell? Buy more?

Our recommendation: If you're worried about a bear market – or simply want to make market-neutral profits – consider a pairs trade that involves shorting Canada.

Shorting Canadian stocks is a way to "pair" any stock holdings you have with an asset that profits as prices fall. It's a way to hedge your portfolio... and get it closer to market-neutral. In other words, we don't look at today's trade in isolation... We see it as part of our "catastrophe-prevention plan."

Why Canada? Because its economy relies heavily on the energy sector, one of the "lions" of the impending crisis Porter has explained...

Canada is full of friendly people and beautiful land. On that land is a wealth of natural resources like oil, natural gas, copper, gold, uranium, and potash. According to the Canadian government, natural resources are responsible for about 20% of the country's GDP.

The sale of oil and gas is by far the largest source of Canada's natural resource revenue. And that's a big problem right now. Over the last 12 months, crude-oil prices are down 58% and natural gas is down 29%.

As they noted, lower energy prices aren't just bad for the oil and gas companies – they're also bad for the entire Canadian economy...

You might think this hurts folks in the energy industry... and you'd be right. But it also hurts Canadian banks, which have funded exploration and drilling operations.

It hurts Canada's real estate sector, too. When energy prices were higher, incomes were higher... And some of that money flowed into real estate. Real estate prices in big Canadian cities (like Vancouver and Toronto) have soared.

According to The Economist magazine's house-price index, Canada's housing market is overvalued by 35% (based on median home prices relative to median incomes). This makes it the third-most-expensive housing market of the 26 countries the index monitors. Relative to rent prices, it's the most expensive market.

But lots of folks in the energy industry have lost their jobs. They are now more likely to default on mortgages. This adds supply and lowers demand for homes... And it hurts banks further.

In addition, these problems put "downward pressure" on the Canadian dollar...

We like to say a currency acts sort of like the share price of a country... And with this big drag on the Canadian economy, its currency is dropping. Over the last year, the Canadian dollar is down nearly 17% against the U.S. dollar.

Lots of folks don't realize that a falling foreign currency affects stock holdings in that country. Canadian stocks trade in Canadian dollars... So when a U.S.-based investor buys Canadian stocks, he's really making two trades. One trade is buying Canadian dollars... And the other trade is buying Canadian stocks with those dollars.

What this means is that if Canadian stocks rise 10% and the Canadian dollar falls 10%, the U.S. buyer breaks even. If both the stocks and the currency fall, the U.S. buyer loses money both ways.

The DailyWealth Trader team recommended shorting shares of the iShares MSCI Canada Index Fund (EWC) as an easy way to bet against Canada...

EWC is a simple, one-click way to gain exposure to a diverse basket of nearly 100 Canadian stocks. It holds 39% of its assets in financial companies and 20% in energy firms.

It's down 24% in the last year... As the effects of low energy prices continue to filter through Canada's economy, shares are likely to continue lower.

Shares of EWC just closed at a new 52-week low today, too. DailyWealth Trader subscribers are up 12% in just more than four months. And as you can see in the chart below, EWC has been a great "hedge," falling much further than the broad market...

Speaking of the energy sector, several additional signs of trouble appeared over the holidays...

In its latest Quarterly Energy Update, published December 23, the Federal Reserve Bank of Dallas noted that bankruptcies in the oil and gas sector have reached levels not seen since the "Great Recession" of 2008-2009. Amazingly, in each of the last two quarters of 2015, bankruptcies were higher than any quarter during the previous crisis.

The report noted at least 10 U.S. oil and gas companies – accounting for more than $2 billion in debt – filed for bankruptcy in the fourth quarter. We don't have an official tally yet, but we can add at least one more company to the list...

Just hours before most folks were ringing in the New Year, Houston-based Swift Energy became the final casualty of 2015. From an article in the Wall Street Journal...

The oil-price collapse put Swift Energy Co. into bankruptcy in the last hours of 2015, with a deal to sell some assets and an agreement with some bondholders, but no guarantees either will be enough to see the company through tough times.

The Dec. 31 filing capped months of struggles to address a debt load that tops $1.2 billion in a climate that has lenders retreating from energy companies. It came as the grace period expired on a missed Dec. 1 interest payment with bondholders that had been engaged in talks with Swift, one of dozens of oil-industry players trying to survive the oil-price crush.

The company filed under Chapter 11 bankruptcy. This is different from Chapter 7 bankruptcy – also known as a "straight" or "liquidation" bankruptcy – where the company's assets are sold off to repay bondholders.

In this case, a majority of the company's senior bondholders have agreed to exchange the debt they hold for equity shares of the restructured company. Meanwhile, the company would continue to operate, and its executives would retain their positions.

According to the Journal, if the plan goes through, it would essentially "swap" $905 million in bond debt for most of the equity in the new company. Existing shareholders would receive just 4% of the new equity.

Despite the filing, the Journal notes that Swift's future looks bleak...

The New York Stock Exchange halted trading of the company's stock on December 18. Shares will soon be delisted and trade only on the "over-the-counter" market.

There's no guarantee the restructured company will survive... meaning all those new shares may not be worth much.

We can't say for certain what will happen to Swift's former bondholders, but we're willing to bet they won't be the last energy investors to be put in this position.

Make sure you aren't one of them.

Finally, in a separate report last week, ratings agency Standard & Poor's noted the number of companies on its "weakest links" list – companies most in danger of default – has jumped to a new post-crisis high. It now has 195 companies, the most since March 2010.

Not surprisingly, the largest number of these companies (34) is in the oil and gas sector. But financial companies are a close second (33)... suggesting that Porter's warnings are correct, and these problems have already begun to spread beyond the energy sector.

New 52-week highs (as of 1/4/16): short position in Capital One Financial (COF) and short position in iShares MSCI Canada Index Fund (EWC).

A slow day in the mailbag. Surely, we've done something to please or disappoint you. Send your questions, comments, and complaints to feedback@stansberryresearch.com.

Regards,

Justin Brill
Baltimore, Maryland
January 5, 2016