The Biggest Threat to the Markets Today

As violent as a mugger... The biggest threat to the markets today... The definition of getting poorer... How the Fed's printing party will end... The bubble-popping pin is on its way... What can investors do today?... 10 stocks to watch as this threat develops...

It's the No. 1 threat on many investors' minds today...

A recent Bank of America survey showed that global investment managers are now more worried about this threat than COVID-19 for the first time since February 2020.

Even the mainstream media can't stop talking about this threat... You won't go a day or two without reading a headline or seeing a news story about what it could all mean for us.

It isn't a new threat, either. Folks in our country have feared its onslaught for decades...

For example, in the late 1970s, former President Ronald Reagan described this threat better than anyone. He said it was "as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man."

Reagan wasn't talking about the perpetrators behind the ongoing Iran hostage crisis at the time... or some rogue organization out to assassinate him. He was talking about inflation... the general rise in prices in an economy.

Here in the U.S., inflation doesn't happen overnight. It's an insidious force that slowly – and often secretly – erodes our wealth, perhaps taking a few decades to notice its real impact...

As comedian Henny Youngman once joked, "Americans are getting stronger. Twenty years ago, it took two people to carry $10 worth of groceries. Today, a five-year-old can do it."

In this Digest, I (Mike DiBiase) will explain why investors are correct to worry about inflation... Right now, it's the biggest threat to both the stock market and the much bigger bond market.

More important, I'll show you what steps you can take right now in your portfolio to prepare for when much higher inflation rears its ugly head. I'll help you develop a plan to survive – and hopefully even thrive – whenever the next crisis strikes in the markets.

Let's start with the biggest myth about inflation...

Many people make the mistake of thinking that a small amount of inflation is good – that it's some byproduct of economic growth. After all, the Fed targets 2% inflation... so that must mean that this is a good amount, right?

But have you ever asked yourself why the Fed wants inflation?

This question has always left me scratching my head... Why would anyone want prices to increase? Do you want to pay more for the same things you bought last year? That's the definition of getting poorer, isn't it?

Wouldn't a rational person want the opposite of inflation – deflation?

Most arguments about why deflation is such a bad thing center around the idea that it's only caused by economic contraction. But this view misses a much bigger point... Deflation doesn't have to be caused by a shrinking economy.

I would argue that most price deflation is caused by economic expansion... resulting from increases in productivity.

And as Henry Hazlitt – the late business journalist and author of the fantastic book Economics in One Lesson – explained...

Inflation is not only unnecessary for economic growth. As long as it exists, it is the enemy of economic growth.

So what causes inflation?

For starters, it isn't a natural outcome of a healthy economy. As Austrian economist Ludwig von Mises tells us...

The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.

More specifically, it's a result of government policy.

Inflation is not caused by the actions of private citizens or businesses. It's caused by the artificial expansion of the money supply by the government. It slowly takes money out of all of our pockets. That's why American economist Milton Friedman once called it "taxation without legislation."

From an economic point of view, what really matters is price inflation relative to wage inflation. In economics, that's known as your "real wages."

As long as your income is rising faster than the rate of inflation, you're getting richer. In other words, your real wages are increasing. But on the flip side... if the rate of inflation is rising faster than your income, your real wages are declining and you're getting poorer.

The truth is... for most people, prices have been rising at about the same rate as their wages over the past 50 years. So their purchasing power is roughly the same.

But here's what most people don't realize... they should be much richer than they are because of massive increases in productivity over that period.

According to the Economic Policy Institute, a nonprofit think tank, productivity in the U.S. is up around 250% since 1948. However, wages are only up 116% over the same span.

You can see when the disparity started to occur in the following chart. Notice from 1948 to the early 1970s, productivity and wages increased at about the same rate – around 2.5% per year. But in the five decades since then, wages have remained flat while productivity has soared...

So what happened in the early 1970s to cause such a dramatic divergence?

Regular Digest readers know that's when President Richard Nixon took the U.S. off the gold standard. Starting in 1971, U.S. dollars no longer needed to be backed by gold.

In other words, it gave the Federal Reserve free rein to print as many dollars as it wanted.

And as anyone who has taken an economics course knows... when more dollars in the system chase a fixed amount of goods and services, prices rise.

This one policy shift unleashed massive amounts of inflation... Without it, we would all be much wealthier today. And without the increases in productivity, prices would be much higher.

But as the above chart shows, this inflation has been mostly hidden from the average worker. With the massive increases in productivity, his dollar should be able to buy more. But it doesn't... and he's none the wiser.

Looking at this chart, you understand what English economist John Maynard Keynes meant when he said...

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

And what led former Federal Reserve Chairman Alan Greenspan to say...

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.

According to the Fed, inflation has averaged around 1.9% per year since 2000. Those numbers are based on the central bank's preferred inflation gauge – called the personal consumption expenditures ("PCE") index.

And the most recent PCE reading was 1.6% in February... So it's still below the Fed's stated goal of 2% inflation over the long run.

However, anyone involved in the real economy will tell you that the Fed's published inflation rate is too low...

Just think about many of the costs in your daily life. From reading the Digest mailbag in recent weeks, it's clear that many of you have experienced rising costs in the real world...

The cost of a college education, for example, has risen around 6% per year since 1985. And health care costs have climbed roughly 5% per year since then, too.

Economist John Williams also believes the Fed's official inflation rate is too low... His ShadowStats website consistently reports a much higher number – around 9% today.

Williams points out that the government has plenty of incentives to keep its published inflation rate at a low level... The official inflation rate determines how much the U.S. government has to pay out for Social Security and pension benefits, for example.

Truthfully, no perfect way exists to calculate inflation... It's different for every consumer. And no matter which method is used, someone will point out all the flaws in the numbers.

But regardless of which numbers you believe, one thing is clear...

Inflation is on the rise today.

To see that, we simply need to turn to the U.S. "M2" money supply. You might remember from previous Digests that M2 is essentially all the money in the system... It includes cash, checking and savings accounts, money-market accounts, and mutual funds.

Now, take a look at what has happened to the M2 money supply over the past year or so...

The money supply is up 28% since the end of 2019. We've never before seen such a steep rise in such a short time. Since the start of the COVID-19 pandemic, the Fed has committed to printing more than $6 trillion to support its stimulus programs. That's more than three times the amount of money that the central bank spent bailing out the U.S. economy during the last financial crisis.

And this likely isn't the final number either...

Keep in mind that this tally is just everything that has already been passed into law – like the Coronavirus Aid, Relief, and Economic Security ("CARES") Act and the American Rescue Plan. It doesn't include the $2 trillion that President Joe Biden just proposed in new infrastructure spending in his recently announced American Jobs Plan... or any other "relief" efforts that pop up in the coming months.

The government is printing and spending like it's Monopoly money... Maybe it should just go the rest of the way and start printing pink $5 bills and yellow $10 bills like the board game.

Any rational human also knows that this game can't go on forever... We're fast approaching a tipping point where it will be "game over" for the Fed. And the game the Fed is playing is called Modern Monetary Theory ("MMT").

Inflation is the enemy of MMT...

Understanding MMT is important... The Fed has been following this policy for years.

(If you're not familiar with MMT, my colleague Alan Gula summarized the idea well in a Digest in November 2019 called, "The 'Magic Money Tree'"... Read it right here.)

The basic tenet of MMT is that governments shouldn't worry about budget deficits...

And MMT says we shouldn't even think of income taxes as the government's main source of revenue. It reasons that governments pay for the things they want by printing more money. (I'm not making this up.) Increasing taxes is just a way to cool an overheated economy.

According to MMT, a government can print as much money as it wants as long as there is "slack" in the economy. Slack means things like stable prices and less-than-full employment.

If any slack at all exists in the economy, the printing presses can keep on running.

Today, we're not at what the Fed considers full employment. The Fed doesn't set a specific unemployment-rate target like it does for inflation... But we know from history that it likes to see the unemployment rate between 5% and 5.5%. Today, it's at 6%.

And as I showed you earlier, inflation is still below the Fed's 2%-per-year target (if you believe its PCE number). Plus, as regular Digest readers will recall, the Fed said last August that it's willing to let inflation run higher than its target for a period of time before it would raise interest rates.

That leads us to the question that no one can answer today...

How fast will all of this recently printed Monopoly money make it through the economy?

Today, banks hold much of it as reserves.

That's why some of my colleagues at Stansberry Research think the fear of inflation is overblown. They don't believe all of this newly printed money will make its way into the economy in amounts that will push inflation well above 2% for a prolonged period.

On the other hand... I can't tell you when it will happen, but I'm convinced it will.

We're already seeing signs of it in parts of the economy, like energy and housing. Gasoline prices spiked 9% in March. And housing prices rose 11.2% in January, according to the latest data.

Once the official inflation rate starts running closer to 3%, the printing party will end abruptly.

That's because the government's only way to fight inflation is through raising interest rates or raising taxes. And neither of those outcomes are good for the markets.

Consumers don't have much power to combat rising prices – but creditors do...

Creditors can demand higher interest rates... And they will.

Inflation makes the dollars that the creditors will get paid in the future worth less. And their only tool to combat this evaporation of future income is through higher interest rates.

In fact, just the fear of higher inflation can throw the credit markets into chaos. These fears are exactly why the 10-year U.S. Treasury yield is up 80% so far this year...

Here's the bottom line... While we can't know for certain exactly when it will happen, higher interest rates will be the bubble-popping pin for both the stock and bond markets.

Higher interest rates make stocks less valuable. Many investors will sell them in favor of safer, higher-yielding fixed-income securities.

Higher interest rates are also a problem for another reason... They cost companies more to service their debt. And as I've explained in the Digest in the past, servicing debt is already an enormous problem for many companies today.

Corporate balance sheets are fatter than ever... The pandemic caused corporate debt to increase $1 trillion last year to more than $11 trillion today – the highest it has ever been.

And many companies are choking on their debt even with interest rates near historic lows...

Today, one out of every four public companies is considered a 'zombie'...

Zombies are companies that don't earn enough profits to pay for their interest costs. They have no hope of ever paying off their debt.

Investors already fear rising inflation and climbing interest rates. A wave of bankruptcies – which is already underway, by the way – will create even more fear in the markets.

As that happens, investors will dump risky, overleveraged stocks. And they'll dump corporate bonds... causing bond prices to plummet and interest rates to go even higher. (The price of bonds and interest rates are inversely related... So as prices fall, yields rise.)

The chain reaction will continue... With more companies defaulting on their debt, banks will tighten credit. And that will lead to even more bankruptcies.

My point is... Much of the current $11 trillion in corporate debt will never be repaid. It will need to be cleared through bankruptcy.

That's why I believe we're on the verge of the next credit crisis.

The Fed has done everything it can to avoid a crisis. But it has exhausted all of its MMT bullets. Firing up the printing press is no longer an option. Interest rates are already just about as low as they can go. Lowering them further will only make inflation run hotter.

We've enjoyed a 40-year stretch in history through which interest rates have fallen. Most investors today can't even remember a period of prolonged rising interest rates.

But the decadeslong downtrend in interest rates is over. I believe they will continue to increase for the next few decades.

And Howard Marks – one of the greatest bond investors of all time – noted in one of his recent memos that rising interest rates are "the biggest risk of all."

So where does this leave investors?

Plain and simple, we're approaching a dark period in stocks.

We're not there yet... But soon, the stock market will struggle to produce anything close to the kinds of returns that investors have seen over the past few decades.

However, that doesn't mean you can't still do well in the markets. It simply means that in the future, it will be more important than ever to know where to invest your money.

To protect your wealth against inflation, you could buy Treasury Inflation-Protected Securities ("TIPS"). TIPs are a type of Treasury security issued by the federal government that pay more as inflation rises. But you're not going to get rich with them... They're a tool for protecting wealth more than anything else.

Of course, the oldest way to fight inflation is by owning precious metals like gold and silver... or shares of the companies that mine these metals. And the newest way is to buy bitcoin – which is sometimes called "digital gold" for this reason. I recommend owning both.

If you're worried about inflation today, precious metals and bitcoin should make up a sizeable portion of your overall portfolio.

Real estate is another good option... My colleague Vic Lederman explained why in the March 18 Digest. As he said, it's a great way to lock in years of market-beating returns.

And you don't need to completely write off the stock market either...

It will be tougher to make money in the stock market in the years ahead, but there will still be lots of great investments... You just need to know where to look.

After all, some companies will make even more profits as inflation and interest rates rise. The key is to be able to identify these companies... and buy them when they're cheap.

The good news is, there's a simple way to know if a company is cheap. Anyone can do it... You only need to look at one number, which is available on most financial websites – the price-to-earnings (P/E) ratio.

After you find the P/E ratio, flip it by dividing it into the number one. This gives you a company's "earnings-to-price ratio." It's more commonly known as the "earnings yield" of the stock.

In other words, it's your share of the company's earnings divided by its stock price. Think of it as what the stock would yield if the company paid out all of its earnings as dividends. You want to own stocks that yield much more than inflation.

Here's an example... Streaming company Netflix (NFLX) has a P/E ratio of around 70 today. Dividing one by 70 gives you an earnings yield of 1.4%.

That's not much of a yield... It's less than today's official inflation rate. The annual earnings on the stock isn't even compensating you for inflation. So unless you think Netflix will be able to grow its earnings much faster than the rate of inflation in the future, you're not likely to do well if you buy the stock at today's prices.

Look for companies with earnings yields of at least 5%, but preferably much higher. And pick companies whose earnings you think are likely to grow as the rate of inflation rises, too... companies with durable competitive advantages and strong brands, for example.

Below is a list of a 10 stocks with high earnings yields today...

These are the kinds of stocks that should do well even as inflation rises.

Plus, there's an even better way to make big returns as the next crisis unfolds, completely outside of stocks...

I'm talking about corporate bonds.

When the next credit crisis arrives – and with everything I've discussed today, I believe that could happen as early as later this year – corporate bonds will get much cheaper.

But as regular Digest readers know, bonds differ from stocks in one important way... They're legal obligations of companies, which must pay you no matter what's happening in the markets.

Just like with stocks, though, you must know which bonds to buy. You can't just go out and buy any bond and expect to become rich. Not all bonds are safe. But the safe ones will help build your wealth during the next credit crisis... when almost everyone else is losing money.

Buying safe corporate bonds at pennies on the dollar is a strategy that the world's wealthiest investors use in times of crisis. When chaos erupts in the markets, it's a strategy that can deliver stock-like returns from investments that are much safer than stocks.

In case you're not familiar, my colleague Bill McGilton and I recommend discounted corporate bonds in our Stansberry's Credit Opportunities newsletter...

And as I've shown, now is the perfect time to join us if you aren't already a subscriber. We would love to help you make a killing when the Fed's money-printing game abruptly ends.

But you don't need to take my word on it...

One of our longtime subscribers recorded a presentation about his own experience with our corporate-bond research. As you'll see, it changed his life... and he doesn't have to ever worry about his retirement income, no matter what happens with the markets.

Before I go, I also wanted to mention one more thing... Right now, you can gain instant access to all of this research at the lowest price we've ever offered. Get started right here.

New 52-week highs (as of 4/13/21): American Homes 4 Rent (AMH), Altius Renewable Royalties (ARR.TO), Brown & Brown (BRO), Richemont (CFRUY), SPDR Euro STOXX 50 Fund (FEZ), Nuveen Preferred Securities Income Fund (JPS), Markel (MKL), Microsoft (MSFT), ProShares Ultra Technology Fund (ROM), Starbucks (SBUX), ProShares Ultra S&P 500 Fund (SSO), Trane Technologies (TT), Vanguard S&P 500 Fund (VOO), Health Care Select Sector SPDR Fund (XLV), and Alleghany (Y).

In today's mailbag, more thoughts about bitcoin and feedback on yesterday's Digest about "home office" life. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Prompted by [yesterday's] feedback from Alliance member L.B., who recently took the plunge and bought bitcoin, I'd like to remind 'scaredy-cats' who haven't yet done so that yes, a 'price tag' of $60,000 is very intimidating, BUT that doesn't mean you're required to spend $60,000. You aren't required to buy a whole bitcoin! Bitcoin has eight digits after the decimal point, so you can buy as little as 0.00000001 of them, an amount that's worth less than a tenth of a penny. If, for example, you want to invest $500, you would order 0.0079 bitcoin. It's that simple. I hope this explanation helps those who haven't yet taken the leap. Just do a little math on the good old calculator and you're golden." – Paid-up subscriber Barbara D.

"In response to your newsletter about any changes from working remotely today, things are pretty much business as usual, since I'm a Realtor and most of us have home offices that we work from anyway. Plus, some of us maintain an office at our company office location too where we can meet with clients or work from.

"The main difference has been that our meetings are no longer at an office, but done via Zoom call meetings. Even our corporate conventions are being done via computer Zoom and videos, which saves me lots of time from having to travel out of state, get a hotel, pay for flights, meals, etc., although I miss seeing over 10,000 Realtors at the conventions to network with and hear classes in person.

"The only change regarding working with clients has been if they want to wear masks, or want me to, and how the sellers decide they want the home shown. Sometimes, the agent will preview the home, take photos, video it to send to clients, or Facetime the clients while they are walking through the property. Some buyers are making offers based upon seeing the home via video, slide shows, or photos and decide within the due diligence period if they will follow through with the purchase.

"The real estate market is the best I have ever seen in 32 years starting at the time the lockdowns from COVID began in 2020. There is a serious lack of inventory; therefore, the prices are going up considerably and selling many times for more than asking price after getting multiple offers. I haven't seen anything like this since the crash when we had lots of foreclosures and short sales, except this market is much better. Thanks for all of your work!" – Paid-up subscriber Alan K.

"Enjoy the commentary. I have an office that I use alone and has an outside door where I can park right outside so I haven't had [to] change." – Paid-up subscriber David M.

"You traveled to your office. I traveled to [a] somewhat familiar office but it's the outdoors of South Africa. I'm standing on mound dirt in the great outdoors, emailing, reading Stansberry and, when [the markets] open, trading a little stocks.

"Things on the way over and things here are very normal, outside masks. No one seems to know anyone recently sick. Hunters on planes, outfitters had their first hunters back since COVID this past week. Let's call it new normal." – Paid-up subscriber Kevin D.

Regards,

Mike DiBiase
Atlanta, Georgia
April 14, 2021