Strange Things Always Happen at the Top
Investors are in the market's 'death zone' today... Strange things always happen at the top... The 'Blackstone Knows When to Sell' triptych... Who said anything about a collapse?... See you at the Ferrari dealer in Greenwich...
Are investors today dying slowly... or much more quickly?
In late May, stories started making the rounds about traffic jams forming atop Mount Everest. It's the world's tallest mountain – a remarkable 29,000-plus feet above sea level.
New Zealand's Sir Edmund Hillary and Nepalese Sherpa mountaineer Tenzing Norgay became the first climbers to scale the mountain in May 1953. Since then, more than 4,800 others have accomplished the grueling feat.
It's an incredibly perilous trek... More than 300 folks have died on Mount Everest over the years, including 12 in 2019, as they reportedly got stuck amid massive crowding in the so-called "death zone" – the part of the mountain above 26,000 feet, approaching the summit.
No kidding... Hundreds of climbers reportedly waited hours for a chance to reach the peak.
But spending too much time at such a high altitude is dangerous for your health. As Peter Hackett – a clinical professor at the University of Colorado School of Medicine's Division of Pulmonary Sciences and Critical Care Medicine – told Popular Science magazine...
You're slowly dying above 18,000 feet. But when you get above 26,000 feet, you start dying much more quickly.
Hackett's quote is an interesting metaphor for the stock market...
When the benchmark S&P 500 Index is trading for more than 1.5 times sales, investors are taking some risk ("slowly dying"). But once it exceeds two times sales, investors' capital is set for a fall from the greatest height possible... In the words of Hackett, it's "dying much more quickly."
Of course, as I've noted a couple of times in the Digest recently, the S&P 500 trades at a price-to-sales ratio of about 2.2 right now. It has only traded above two times sales on one other occasion in history – the peak of the dot-com bubble roughly two decades ago.
Two times sales is the "death zone" for future equity returns. According to economist and asset manager John Hussman, the index's 10-year returns have been abysmal any time it has approached anywhere near this level in history. In the October 3 Digest, I explained what happened back in 2000...
Hussman chimed in recently on Twitter, pointing out that the most overvalued 10% of stocks in 2000 lost 80% of their value in the bear market that bottomed in the fall of 2002. Hussman added ominously, "Currently, every remaining decile (1/10) of S&P 500 components trades at a richer [price-to-sales ratio] than in 2000."
In other words, 90% of U.S. equities are more expensive right now than they were at the peak of the dot-com bubble. By implication, the inevitable bear market will be a lot more painful than the 2000-2002 rout that took the benchmark S&P 500 Index down 49% and the Nasdaq Composite Index down 78%.
Of course, scaling Mount Everest is an expensive experience these days, too... According to a recent article in the New York Times, a typical expedition can easily cost more than $50,000.
Given the "wealth effect" – the behavioral economic theory in which higher stock market winnings inspire more lavish spending – I assume we'll see far fewer traffic jams on Mount Everest if the stock market behaves as Hussman expects. A decline of 50% or more would be a run-of-the-mill performance from these levels, if history is any guide.
The lines on Mount Everest are similar to the massive crowds at Ferrari dealers in the New York City suburbs before the housing bubble popped more than a decade ago. I assume nobody died from a lack of oxygen while waiting to spend six figures on a car, but who would bat an eye if the news reported one of them was strangled by... just about anybody? I'm sure stranger things have happened before.
Strange things always happen at the top...
As legendary investor Warren Buffett likes to say, you don't know who's swimming naked until the tide goes out. You find out who has been wearing a wetsuit, too.
Some guys just know when to sell...
Take mega private-equity firm Blackstone (BX), for example. It has demonstrated an uncanny knack for enticing investors to buy its shares just when those same investors are about to take it on the chin.
"Blackstone Knows When to Sell" happened for the first time back in July 1998...
At the time, Blackstone was still a privately held partnership. The company sold a 7% stake for $150 million to insurance provider American International (AIG). As part of the deal, AIG also agreed to provide an additional $1.2 billion of investment capital to Blackstone.
As the Wall Street Journal reported back then, the Blackstone-AIG deal came at a time when institutional investors – apparently more interested in failing conventionally than succeeding unconventionally – were pouring "unprecedented amounts of capital into leading buyout firms."
Blackstone didn't say how it would use the additional $1.2 billion at the time. But you know how it goes... Borrow $1.2 million, you have a problem. Borrow $1.2 billion, and the bank has a problem.
The risk landed on AIG's balance sheet. All signs point to Blackstone cashing up in the face of what the company – and in hindsight, embarrassingly few others – viewed as a potentially imminent downturn. As we now know, Blackstone was spot-on...
A month after Blackstone sold the 7% stake to AIG, the Russian government defaulted on its debt... crushing the Russian ruble and many hedge funds trading the country's bonds.
Long-Term Capital Management became the most notable victim...
Longtime Digest readers likely recognize the company's name. It was headed by a motley crew of pedigreed academic geniuses and Salomon Brothers alumni who didn't survive that firm's famous Treasury bond scandal in the 1990s, as well as two Nobel laureates.
Apparently, they were all uniquely talented in the fine, complex art of borrowing $100 billion, levering up 100-to-1, buying a boatload of bonds... and blowing it all sky high.
If the company had just one more Nobel Prize-winning financial-rocket scientist on its staff, it might have reached escape velocity, shot straight into space, and be sailing past Uranus today.
Instead, it merely threatened the integrity of the entire global financial system... requiring a $3.6 billion bailout from a consortium of 14 banks (which were run by even more financial weapons researchers, as we learned a decade later in the 2008 financial crisis).
In Wall Street, politics, and academia... it seems that you never really know who you've been dealing with until they retire, die, blow up, or get arrested.
Before we move on, let me just say this...
I'm definitely not Nobel Prize material, but I bet I could collapse the entire global financial system with the best of 'em! Just lend me $124 billion and watch me work – like some brainiac arsonists did with Long-Term Capital Management two decades ago. (No kidding!)
In the fallout from the Long-Term Capital Management debacle, U.S. stocks fell nearly 20% in a span of roughly six weeks from July 17, 1998, through August 31, 1998. The dot-com frenzy topped out less than two years later, kicking off a two-year bear market.
Blackstone: 1, Market: 0. Coincidence? Maybe... maybe not.
"Blackstone Knows When to Sell, Part Deux" was written and performed in July 2007...
The firm went public just three months before the housing bubble peaked and led into a 17-month bear market that took the S&P 500 down 58%. Pure coincidence, right? These guys can't possibly be a band of living, breathing, bonus-mongering sell signals... can they?!
'Blackstone Knows When to Sell, Chapter III' – in my mind, at least – just happened a few months ago...
I'm talking about Blackstone's conversion from a publicly traded partnership to a regular C corporation ("C-corp"). Why would the company decide to do that?
It's simple. Blackstone wanted to sell into the biggest frenzy of our time... index funds.
When announcing the decision in April, Blackstone CEO Steven Schwartzman – who I like to think of as "Vlad the Impaler" (every ten years, he rises up and kills everyone who buys his stock) – said other companies that transitioned from partnership to C-corp had "experienced strong stock price performance, a meaningful pickup in trading volume, and a significant increase in mutual- and index-fund ownership."
For everyday investors, those three considerations mean jack-diddly squat. But to people running portfolios full of levered-up, illiquid assets that can't sell at the drop of a hat... they mean absolutely everything.
In other words, mutual funds and other institutional portfolios have rules against buying partnerships. They're too messy at tax time. The change to a C-corp means anybody and everybody on Wall Street can now load up on Blackstone's shares. Large institutions dominate trading activity today, so you have to sell what they're allowed to buy.
All hail stock price, trading volume, and the institutional bid. May they forever facilitate the payment of eight-figure bonuses.
Blackstone's switch from partnership to C-corp became official on July 1. On July 26, less than a month later, the S&P 500 hit a new all-time high... then promptly fell nearly 7% in less than three weeks.
For now, it's easy for most investors and talking heads to write it off as a minor correction... But what if it's not?
What if it's a repeat of the 1998 Blackstone-AIG deal, with the market selling off in the near term and eventually giving way to a serious bear market less than two years later?
Are we once again looking at a massive "Melt Up" over the next year and a half... followed by an equally massive bear market rout for another year and a half after that?
It might be too much to expect history will rhyme that closely, but you have to admit... Blackstone is building a nice track record of facilitating the sale of its own stock into the frothy markets that prevail just before minor hiccups, major hiccups, and the near total suffocation of major bear markets.
And remember, private-equity firms need some way to sell. They're in the business of owning giant, stinking, levered-up piles of garbage they can't sell because they'd have to write it down to reality and admit it's garbage – endangering their sacrosanct bonuses.
The "Blackstone Knows When To Sell" triptych took up just a fraction of my 35-minute presentation on Monday afternoon at the annual Stansberry Conference in Las Vegas. (You can learn how to access that, and all the other presentations at the conference here).
Among other alarming items, I alerted the crowd to the trouble on the other side of the Atlantic...
Specifically, I pointed out a September 12 post on Twitter from the European Central Bank ("ECB"). It read simply, "Draghi: Negative rates will not provoke the collapse of the financial system."
Collapse? Who said anything about a collapse?!
It's a classic "we will not devalue the currency" moment, in which Mario Draghi – the outgoing president of the ECB – told us the truth by lying to our faces. Perhaps Draghi even knew we would really hear, "Yes, the financial system will collapse, but when it does, you can't pin it on me because I telegraphed it in this highly informational tweet."
It's like a fearful teenager who comes home from school one day, walks over to his mom at the kitchen table, and says, "If school calls and says I was absent today, they're lying."
Oh, yes, I'm sure you were there all day, mister. Now, march straight up to your room and stay there until every bond in the eurozone yields more than 0%! Kids these days. Oi!
If the Nobel Prize-winning financial-system crashers at Long-Term Capital Management were substantial talents in their day, Draghi and the ECB are certainly in a class by themselves. If it takes a Nobel Prize to lever up and crash the system, it must take Einstein-level genius to turn the sovereign debt of Western developed countries into dot-com-like toxic waste.
Geez, now that I think about it, maybe I couldn't crash the financial system if someone gave me $124 billion. Ruining everything you touch with leverage and total ignorance of basic economics might require some supercharged brainpower after all...
Heck, it's all above my pay grade anyway. I'm just trying not to die on this mountain, trying not to blow my little corner of the world sky-high when they light the fuse on this sucker.
For three years, I've been telling anyone who would listen to hold plenty of cash, plenty of gold, and buy value stocks when and where you find them. Given the performance of gold, the sleep-enhancing benefits of a pile of cash, and the recent outperformance of the value-stock indexes, I'm starting to feel like you and I might just escape what's coming in one piece.
I guess that means it'll be you, me, and all the know-when-to-sell Blackstone employees in line at the Ferrari dealer in Greenwich, Connecticut, after it all blows up.
I want a red one. See you there.
New 52-week highs (as of 10/10/19): Nuveen Preferred Securities Income Fund (JPS).
In today's mailbag: Several more readers share their thoughts on the 2019 Stansberry Conference (including one of this year's presenters)... and another weighs in on yesterday's Digest. As always, send your notes to feedback@stansberryresearch.com.
"Bravo, another great gathering. [Dennis Miller] was unrepentantingly irreverent and insightful as ever. The stunning intellects of [Jim] Grant, [Nouriel] Roubini, and [George] Gilder – and with no intent to ignore that of others – what a Dean's List of presenters! The arguments of the market's 'fair value' or it's 'excess exuberance' were both solid. I tried to weave the middle from them, but hatched only the same shrug as most others. I take home many good ideas... Thanks for your work!" – Paid-up subscriber J.L.
"I enjoyed the Alliance Day [livestream on Wednesday]. Listened on my [headphones] while I worked. Thank you for making it possible to enjoy part of the conference." – Paid-up Stansberry Alliance member Anita K.
"Thank you, Justin. What a write up and I appreciate it. I had an absolute blast speaking. The whole process was first class and I sure thank everyone. The whole staff is warm and caring. The passion of Stansberry is alive and well and I was honored and humbled to be a part of it!!" – Paid-up Stansberry Alliance member Clay Lowder
"Hi, Matt! Great Digest [yesterday]! Especially the comment about being willing to hold a stock for a decade. Really puts things into perspective. It was great meeting you [in Las Vegas this week]. I hope to catch up with you next year! Don't let that mean bully Doc push you around too much in the meantime 🙂 Take care!" – Paid-up Stansberry Alliance member Jesse H.
Good investing,
Dan Ferris
Vancouver, Washington
October 11, 2019
P.S. As you should know by now, I believe the overall market is setting itself up for a bear market. (And we may have already entered one. We'll see.)
In any case, there will be opportunities to escape in one piece and make money during bear markets and corrections for the next several years.
I've described how to do it – and identified three stocks you must own – in a new special report for my Extreme Value subscribers. Click here for the details on how to get it.