What You Should Buy When the 'Credit Crisis' Hits
Editor's note: A credit collapse is approaching... But you can profit from the pain.
Stansberry's Credit Opportunities editor Mike DiBiase has been warning of the coming crisis for more than a year. According to Mike, the Federal Reserve has painted itself into a corner with unprecedented pandemic stimulus. And when the collapse hits, a wave of bankruptcies will lead to some of the best distressed-debt opportunities you've likely ever seen...
Today's Masters Series is the conclusion of Mike's two-part conversation with Digest editor Corey McLaughlin. Read on to learn why Mike says the coming credit crisis is inevitable... why the Fed is helpless to stop it... and how you can lock in safe gains while the rest of the market is panicking...
What You Should Buy When the 'Credit Crisis' Hits
Corey McLaughlin: You wrote a Digest several months ago warning about a recession coming later this year, before most other people started talking about the idea. First off, what are your thoughts on that now?
And second, should we think the next "credit crisis" will arrive with the next recession, or not necessarily? And what makes you say so? What's your outlook?
Mike DiBiase: Corey, I've been trying to warn folks about what's coming for more than a year. There's no avoiding a recession at this point. A recession is simply two consecutive quarters of declining gross domestic product ("GDP"). U.S. GDP shrank 1.5% in the first quarter. We're already halfway there.
I thought the COVID-19 pandemic was going to cause the next credit crisis in 2020. I was wrong. I didn't foresee the size and scope of the Federal Reserve's response.
The Fed injected massive amounts of liquidity into the markets. It even promised to buy corporate bonds for the first time in its history. Its unprecedented measures pulled our country out of a recession after just two months, making it the shortest recession in U.S. history.
But the Fed made a big mistake. It left its printing presses on far too long. That caused the U.S. money supply to skyrocket. I saw that it was growing faster than at any other point in history.
That's why more than a year ago in a Digest – when inflation was still at less than 2% – I called inflation the biggest threat to the markets. Because of the massive increase in the money supply, I knew inflation was headed much higher.
It takes time for money-supply increases to make their way into the economy. That's why we didn't see rampant inflation right after the pandemic when the Fed switched its printing presses into overdrive.
It's really simple... Big increases in the money supply cause inflation. The late Nobel Prize-winning economist Milton Friedman said it best... "Inflation is always and everywhere a monetary phenomenon."
According to Friedman, it doesn't matter whether a country is capitalist, socialist, or communist. Inflation is always caused by the same thing – a more rapid increase in the amount of money than in output of goods and services.
In other words, inflation is a printing press problem.
CM: I couldn't agree more. With all the talk about inflation today, you haven't heard many politicians talk about the government's role in fueling it. It's always something else...
MD: Of course not. Why would they admit it? Folks today don't seem to understand this. They're being fooled by the Fed's smoke and mirrors. The Fed wants you to believe inflation is caused by supply-chain problems... or COVID-19 lockdowns and restrictions... or rising gas prices... or the war in Ukraine.
I'm not saying those things have no effect. They do. But they aren't the root cause of the problem. They're just making inflation a bit worse than it would have been.
The Fed is a long way from fixing the problem. In fact, it was still increasing money supply at an annual rate of 10% as recently as two months ago, when it reached nearly $22 trillion. Inflation had been at multidecade highs for months at that point.
Let me give you some rough baseline numbers that tell the story...
Over the past 60 years, the U.S. money supply has grown at a rate of just under 7% per year. Over that time, inflation has averaged around 3.5%. Inflation lags the growth in the money supply because of increases in output. Our country's real GDP – a measure of output – has grown at an average rate of around 3.1% over this time.
Now here are the scary numbers...
The Fed has grown the money supply by more than 40% since the start of the pandemic. That's more than 20% annual growth over the past two years. At normal 7% growth, it would have taken until 2025 to reach today's money supply level. Said another way, the Fed jammed five years' worth of money-supply growth into two years.
That's unprecedented and abnormal. The only time the money supply has even approached that pace of growth was from 1975 to 1977, when the money supply grew around 30%.
Not surprisingly, right after that, inflation rose to more than 10% and didn't peak until 1980 at nearly 15%. It took Fed Chairman Paul Volcker raising interest rates to 20% to bring it back down.
CM: That is a scary comparison...
MD: What's more scary is the Fed can't fix the problem without killing our economy. You can forget about a "soft landing." The Fed is now backed into a corner. It's left with two choices... higher interest rates or higher inflation. Both are deadly for our economy. It's a lose-lose situation.
That's why I think the next recession can't be avoided. And it's also why it will be much worse and much longer than most people think.
The Fed is now playing catch-up trying to fix its mistakes. It finally began raising interest rates. And it promised to begin reducing the money supply. They should have done those things last summer. It's too late now.
In order to make a significant dent in inflation it has to make big, fast moves. It's not. The moves it's planning are too small and too slow. The Fed knows that if it moves too fast, it will trigger a steep economic slowdown and set off the next credit crisis.
On the other hand, if the Fed suddenly reverses policy and tries to lower interest rates and make credit easy once again, it will have the same effect. The only way it can do that is by flooding the market with more liquidity. In other words, printing more money. That will cause even worse inflation, which will also trigger a recession.
The Fed is out of bullets. That's why I think we're going to see the next credit crisis very soon. Many companies will go bankrupt and bond prices will plummet. This is the moment we've been waiting for since launching our newsletter in 2015.
We'll be able to recommend safe bonds for pennies on the dollar. It will be the kind of opportunity that comes along once in a generation.
Don't get me wrong... I don't want to see our economy tank. I'm not looking forward to seeing people in economic pain. But the excesses of the past few decades have led to a ton of bad debt that needs to be cleared. In the long run, it will be good for our economy.
We can't defer the pain forever. I want regular investors to know there's a way they can at least profit from the coming crisis.
CM: It's always stunning to me – though maybe it shouldn't be – just how many companies can be considered "zombies" today. What's the deal with that? And in a roundabout way, I guess they actually help create the types of opportunities in good businesses that you look for. Is that right?
MD: Exactly. Today, a record number of companies in the U.S. are considered zombies... companies that can't afford the interest on their debt. Even with record-low interest rates.
Nearly one out of every four companies is a zombie. That's the most by a long shot. It's higher than before the last financial crisis and higher than the previous peak of 17%, set back in 2001.
These companies are living on borrowed time. They're dependent on creditors who are willing to lend them more money when their debt comes due. They might be banking on their businesses turning around as they burn through their cash... or they might have plans to sell assets... or issue shares of stock to pay down debt.
The next recession is going to bury many of them. Zombies are already choking on today's higher interest rates and inflation. An economic downturn will be the final nail in the coffin.
And when record numbers of companies suddenly go bankrupt, no one is going to want to own corporate bonds. That's the very best time to buy them.
Some people say the bond market predicts stock market problems. But that's not always the case. The recent stock market downturn is a good example. Compared to the stock market, the bond market has been pretty calm.
The bond market is a pretty good predictor of the economic dangers that lie ahead. So it's worth paying attention to. It's less volatile than the stock market. Bond investors tend to be more analytical and have a longer-term view of the market. They're also less emotional and more patient than equity investors, who trade in and out of stocks on the smallest news or rumor.
You start to see fear creep into the bond market before problems appear in the overall economy, like recessions. I'm seeing that today.
CM: What conditions do you look for in the credit market? You're not necessarily talking about "backing up the truck" to buy corporate bonds just yet, right?
MD: Right. This distressed-bond strategy works best during a credit crisis... when there's real fear in the markets. That's when you back up the truck.
That's when bonds go on sale. I'm talking deep discounts. Remember, bond prices and returns are inversely related. The lower the bond price, the higher the return.
We're not there yet. But we're getting close...
You can gauge fear in the credit market by looking at what's called the high-yield credit spread... It's the difference between the average yield of less creditworthy junk bonds and the yield of similar-duration U.S. Treasury notes.
It's measured in basis points ("bps"). A spread of 600 bps means that junk bonds yield 6% more than U.S. Treasurys. That's about the average throughout history.
Today, the spread is around 500 bps, below the historical average. But it has been rising. At the start of the year, it was around 300 bps. That tells me the credit market is starting to worry.
Still, even during calm markets, there are normally a handful of what we call "outliers" every month... safe bonds that trade for much less than they should. An outlier could be caused by a company getting its credit rating downgraded, a bad quarter, or some other negative news surrounding the company.
But no doubt, this strategy works best during crises. We haven't seen a real credit crisis since 2009. But I think we're on the cusp of the next one right now.
You'll know it's a real crisis when the spread soars to more than 1,000 bps. During the 2008 financial crisis – which I would call the last true credit crisis – the spread soared to more than 2,000 bps.
Like I said, I think we're on the verge of the next credit crisis. I wouldn't be surprised to see the spread challenge that number this time around.
CM: So you're saying you want to buy when the next credit crisis hits. That could be counterintuitive to people. Let's give an example...
If I recall correctly, during the panic of March 2020 – when the pandemic hit the U.S. – you recommended a lot of positions in a very short period of time.
MD: Exactly. When the World Health Organization declared COVID-19 a pandemic in March 2020, the high-yield spread suddenly spiked to more than 1,000 bps. We jumped on the opportunity and recommended eight bonds within a span of a few weeks while the spread was wide.
I believed back then that we were headed for another credit crisis. But the Fed stepped in with unprecedented monetary stimulus and calmed the market. The wave passed almost as quickly as it came and the spread narrowed.
We used the calming of the market to do something we love to do... sell bonds for more than par value long before they mature.
If someone is willing to pay you more than the contractual amount you're owed, long before maturity, you jump on that. That only increases your returns.
We closed all eight bonds for gains by the end of 2020. We sold them all above par value and booked an average return of 18%, holding them just 112 days on average. On an annualized basis, that's a 59% return. And these were all very safe bonds.
This is an example of why every investor should consider bonds. I don't know where else you're going to find safe returns like that.
Editor's note: Since the onset of the pandemic, Mike and his colleague Bill McGilton have used their unique distressed-debt strategy to help subscribers achieve a 91% win rate... with an average return of 14.7%, or 35.5% annualized.
But Mike believes the COVID-19 crash was only the beginning – and the coming credit crisis will produce a wave of bankruptcies unlike anything we've seen in more than a decade. He says the collapse could hit by the end of the year... and now is the perfect time to start preparing. Get the details here.