Editor's note: The global coronavirus pandemic is a true "black swan" event...

No one saw it coming.

Soon after it spread to the U.S., the government and the Federal Reserve quickly stepped in with massive, never-before-seen stimulus. And now, investors are growing optimistic that things will soon return to normal... The stock market has surged higher in recent weeks.

But Stansberry's Credit Opportunities editor Mike DiBiase believes investors still need to be cautious...

In today's Masters Series essay – adapted from the April issue of Stansberry's Credit Opportunities – Mike details why the Fed's "reinflating magic" won't work and why we won't return to normal anytime soon. As he explains, investors are focused on the wrong thing...

The Corporate-Debt Bubble Is Popping

By Mike DiBiase, editor, Stansberry's Credit Opportunities

No matter how hard you try, you can't un-pop a bubble...

I'm talking about the corporate-debt bubble.

As I'll explain today, it's finally popping after years of excess...

Mortgage debt was the bubble that caused the last financial crisis. This time, the bubble is corporate debt. U.S. companies owe a record $10 trillion today. Mortgage debt is up only 9% since 2008... but corporate debt is up 75% in the same span.

Meanwhile, the credit quality of corporate debt is at an all-time low. Around one out of every five companies struggle just to pay the interest on their debt.

In short, corporate America can't afford a recession...

Unfortunately, a recession – two straight quarters of declining gross domestic product ("GDP") – is all but a guarantee now. The only question is whether the global shutdown caused by the coronavirus pandemic will turn the recession into a full-scale depression.

More than 22 million Americans filed for unemployment over the past four weeks. That's around 15% of the workforce. And it's going to get worse before it gets better...

Economists at the Federal Reserve predict the unemployment rate will hit 32%. That's more than seven points higher than the peak of the Great Depression. It's a dire situation, especially considering around half of all Americans already live paycheck to paycheck.

Even if all the "shelter in place" directives across the U.S. ended tomorrow, it's naïve to think that all these unemployed folks would find work immediately.

The situation is going to be worse in developing economies that don't have the recourses to help the unemployed that we do here in the U.S. The International Monetary Fund recently said we're facing the worst global economic crisis since the Great Depression.

The Federal Reserve and the U.S. Treasury are using every weapon in their arsenals to prevent it. Since the middle of March, they've unleashed more than $5 trillion in financial stimulus. Expect more in the months ahead, including a $2 trillion infrastructure bill.

Investors seem confident that these efforts will work...

The benchmark S&P 500 Index is up more than 25% from its March 23 low. It's now back in bull market territory – at least by the common "20% move higher" definition.

It's the same story with debt investors... The largest investment-grade and high-yield bond exchange-traded funds are up around 20% from their lows in March.

Many folks believe that once the coronavirus threat is behind us and everyone returns to work, things will go back to normal.

Investors are partying on the deck of the Titanic. But I think they're making a big mistake...

As economist and author Peter Schiff recently reminded us, investors are focused on the "pin" (the coronavirus) rather than the "bubble" (corporate debt). It's wise to listen to Schiff... He famously predicted the last financial crisis long before it happened.

It's understandable for so many folks to focus on the virus and "flattening curves." But they're missing a key point... any economic downturn was a threat to this credit bubble. If it wasn't the virus, another "pin" would have popped it.

The global economy is suffering a heart attack. It has been shut down for nearly two months so far... something that has never happened before. Plain and simple... we're not returning to normal anytime soon.

No matter what reinflating magic the Fed tries, it won't work.

Aside from a few unusual examples, like video-conferencing software maker Zoom Video Communications (ZM), most companies' sales have cratered over the past two months. Some have fallen to close to zero.

With the economy shut down, nearly every business is doing one or both of the following...

1. Burning through cash
2. Taking on additional debt

Many companies are being forced to borrow just to pay salaries and other basic expenses. Their cash balances are getting smaller and their debts are growing larger and larger by the day.

Here's an important point to remember about the Fed's crisis-averting stimulus efforts...

Aside from the airlines and small businesses, companies eligible for the central bank's bailouts to date aren't getting free money. They're not handouts... They're loans that must be paid back.

The Fed is stepping in when no one else will loan money to these companies. The bailout is doing nothing more than adding to the already record amount of U.S. corporate debt.

And it's not lending money to just any company... It's only lending to companies with investment-grade credit ratings or companies that were downgraded from investment-grade after March 22.

Investment-grade credit ratings are anything from "AAA" to "BBB." Non-investment-grade – or "junk" – credit ratings are "BB" and lower. Here's a breakdown...

To qualify for the Fed's loans, a company that was downgraded after March 22 must maintain a rating of at least a "BB-," according to ratings agency Standard & Poor's (S&P).

But the thing is... the companies that most need the help are the junk-rated companies. And the Fed isn't doing anything to help them.

Shutting down the economy for at least two months has severe ramifications on companies' credit ratings...

As their debt piles grow larger, corporate profits will fall dramatically this year. That means companies' debt-to-earnings ratios are about to skyrocket, which will lead to an increasing number of credit downgrades. We're already starting to see that happen...

In the first quarter, S&P downgraded 739 North American companies. That's more than any quarter during the last financial crisis. Look at the quarterly breakdown below...

And so far in April, S&P has downgraded another 387 companies for a total of 1,126 this year. It downgraded 906 companies last year. In other words, we've already seen more downgrades through three and a half months than in all of 2019.

At the peak of the last financial crisis, S&P only downgraded 1,500 companies in a single year. If the current pace continues through the rest of 2020, we'll see roughly 3,700 downgrades. That's a staggering number.

This is important because downgrades always precede defaults. (That's when a company can't pay its interest or principal as it comes due and must file for bankruptcy protection.) After experiencing downgrades, companies must pay higher interest rates to borrow.

So in turn, we can expect defaults to soar in the months to come...

S&P currently forecasts a 10% high-yield default rate. That's the percentage of companies with junk credit it expects to default within 12 months. Its current "pessimistic" forecast projects the default rate to reach about 13% by the end of the year. That would be a new 40-year high.

The default rate is a critical number... When it begins to soar, investors become fearful. They want nothing to do with high-yield bonds. The junk-credit market can dry up quickly.

The last time that happened was in December 2018, when investors were worried about rising interest rates. Companies with junk credit had no one willing to lend them money. So the Fed began lowering interest rates in an attempt to stop the bleeding. It worked.

We're once again seeing the market dry up for junk borrowers. Look at the following chart, which shows the amount of junk bonds issued by month. You can see investors are scared to lend junk-rated companies money today...

Don't expect the Fed to save the day today like it did in 2018. We weren't dealing with a global recession then. And the Fed has already lowered rates down to zero this time.

Chairman Jerome Powell said earlier this month that the Fed can only lend to "solvent" companies. So don't expect the central bank to bail out any junk-rated companies.

Things are going to get much worse for junk-rated companies with large amounts of debt maturing this year. The sins of their debt binge will finally catch up with them. And as the number of bankruptcies starts to escalate, investors will want nothing to do with junk debt.

As default rates start rising, the same thing will happen with the high-yield credit spread. That's the difference between the average yield of so-called "junk" bonds and the yield of similar-duration U.S. Treasury notes. The spread has once again narrowed to about 735 basis points ("bps") after briefly soaring to more than 1,000 bps on March 25.

S&P believes the high-yield credit spread will soon approach 1,600 bps. I expect it to go even higher than that... During the last credit crisis back in 2008, the high-yield credit spread peaked at 2,200 bps. That's more than double where it reached in late March.

Irreparable damage has been done to the economy. And the longer the shutdown lasts, the worse it will be. For the most leveraged companies, it's a death sentence.

Unfortunately, many investors haven't yet seen the destruction. Like a tornado that struck in the middle of the night, the damage has been hidden from view.

However, the sun is coming up, and it will soon all become clear...

Over the next few weeks, we'll get a much better idea about the extent of the damage done so far. Companies began reporting first-quarter results last week. Many more will report in the weeks ahead. I believe the numbers will be much worse across the board than most people expect.

And keep in mind, this is just the beginning...

The shutdown only impacted a few weeks of the final month of the first quarter. The second quarter will be much worse since shelter-in-place orders will have been in place for longer.

It's possible some businesses could be shut down for many more months. And even if businesses are allowed to open soon, a second wave of the virus could shut everything down again.

For now, the Fed's unprecedented stimulus has given new life to the markets. But don't be fooled... Just because the markets are up and high-yield credit spread is falling today, doesn't mean the storm clouds are gone.

No one wants to see people losing their jobs and their personal wealth destroyed. But here's the most important point... You don't have to be a victim.

In tomorrow's essay, I'll tell you what one world-class investor is doing to prepare for the crisis. He has learned to make a killing in times like these. And I'll explain how you can, too.

Regards,

Mike DiBiase

Editor's note: The recent crash started paving the way for the kinds of safe, distressed-debt opportunities that Mike hunts for in Stansberry's Credit Opportunities... In fact, he recently identified three "crisis bonds" to get you started before the real storm arrives.

This strategy also helped one of our paid-up subscribers retire at age 52... and sleep easy through the latest market turmoil. So while "sheltering in place" in his living room in New York, he recently went on camera to reveal all the details. Listen to his story right here.