Porter Stansberry: The single best way to profit from the coming credit crisis
From Porter Stansberry and Bill Bonner in Stansberry Digest:
The corporate-credit market is about to collapse.
Are you prepared?
Today, we’re kicking off a two-part series that features an excerpt from a recent conversation Porter had with his longtime business partner and professional mentor Bill Bonner.
In today’s post, Porter and Bill discuss the difference between investing and speculating… central banks’ roles in manipulating the global economy… and how to maximize your profits as the default cycle begins to unfold… Tomorrow, we’ll cover a single statistic that will tell us exactly when the credit default cycle has started.
Porter Stansberry: Bill, I want to talk to you about the biggest investment idea I’ve ever had in my 20-year career.
I call it Stansberry’s Big Trade. It’s a way to profit from the coming collapse in corporate credit.
There’s a big difference between investing and speculating. Could you start us off with what your definition of speculation is? Because I’d like to make it clear to everybody, what I’m suggesting you do with the collapse in credit is not to make an investment but to make a speculation.
Bill Bonner: There’s no bright line between speculation and investing. There is a frontier, but it’s hard to find.
When you really invest, in my mind, you need to know what you’re doing. You go into a business that you’ve studied, you look at the financial return on your investment, you look at the assets, you look at the people. That’s a real investment. Where you know what you’re doing.
In speculating, for example, you could have taken a bet on the election. If you thought the election was going to Trump, you might take a different position than if you thought it was going to Hillary. That’s a speculation. Because you really don’t know.
And speculators typically speculate based on price, as well as events. You could guess about what’s happening in the gold market. You could guess about what’s happening in technology, and so on.
Those are speculations because you really don’t know anything about the return rate. You’re just guessing about what you think might happen.
Porter: Another way of saying that would be: Speculation is about understanding the odds, or as you said, the prices.
One of the unique things about the setup I see right now in the markets is that the price of risk – which I would define as the prices on put options for major U.S. equities – is near all-time lows.
As you know, the prices of puts are indexed by something called the Volatility Index (or “VIX”). The VIX’s all-time low was around 10. And it has been below 14 for 30% of this year. It has even been as low as 12.
The index perceives almost a complete absence of financial risk in the markets today. Meanwhile, the default rate on junk bonds continues to increase.
We now see all kinds of warping, problems, and leverage unlike anything we’ve seen before in the financial markets. That is due to the central banks.
By my calculation, central banks – over the last six or seven years – have printed up $17 trillion worth of new money and credit. And they’ve spent it almost exclusively in the bond markets around the world.
What have you seen the central banks do that has you the most concerned?
Bill: I think the same thing that you’ve seen, Porter. They’ve been distorting the whole market system.
The Federal Reserve and the world’s central banks put so much phony money into the markets. They have boosted up the price of assets… They’ve given this impression that they are behind the whole market system. That’s why investors think there’s no risk.
They think the central banks are behind the whole system and that they can’t afford to let it fall… which is true. They can’t afford to let it fall.
But at a certain point, they have no option. The markets are huge. We’re talking hundreds of trillions of dollars in various sorts. Including derivatives, you’re talking a lot more. That’s $17 trillion that can disappear overnight in the world markets.
So these central bankers have pumped up the whole world economy, pumped up asset prices all over the place. And there’s no way in the world those assets are really worth what they say.
Now, you’ve come up with kind of an ingenious way to take advantage of it that I’d like to hear more about.
Porter: Yeah. I want to get to the specifics of the trade. But I also want to make sure people have a concrete example of what you’re talking about.
You remember back in the mortgage bubble from 15 years ago. It was very easy for people to see that, “Man, all of a sudden, everyone on my block is a house flipper.” Or a developer. Or a giant landlord.
And there are the stories from The Big Short where go-go dancers in South Florida had four or five separate mortgages. You could see this happening around you.
When people talked about the “Greenspan put” or the way the government was inflating housing, it was easy for people to look around and see what they were talking about.
And what’s funny to me is that I think the mortgage collapse was the most anticipated collapse of any bubble in the history of the world. Everyone knew that you can’t get rich trading houses with your neighbor. It doesn’t make any sense.
Bill: In the mortgage bubble, you could see it. Everybody was flipping houses.
We all knew that it was impossible to get rich by flipping houses with your neighbor and then taking the equity out all the time. That was clearly not going to work.
But now what we see are these negative-interest bonds… negative interest rates… $13 trillion worth of bonds trading below zero. This implies money – real capital, real savings – is worthless. It can’t be.
There are people in Switzerland right now who are living in houses that they bought on negative-interest-rate mortgages… which means they borrowed the money from a bank to buy the house and the bank sends them a check every month.
Porter: That’s right. And if you start following that logic, you understand why Deutsche Bank almost collapsed this summer.
That’s the No. 1 sign that what has happened is unsustainable. It should be obvious to everyone that negative interest rates are the opposite of capitalism. It’s capitalism inverted.
And then, even if you don’t understand that, you’ve got to realize there’s no way the banks can afford to pay you when you’re borrowing their money. It simply won’t work.
That gets us into this idea of timing. I want to get into what we’ve done, anticipating what we know has to happen going forward.
My team buys an enormous amount of data on corporate credits. We buy a full credit profile on 40,000 different corporate-debt securities every month. We have a team of two CPAs and a lawyer who go through all of these data. And we produce our own credit ratings on 3,000-4,000 issues every month.
Now, you say, “What’s the difference?”
Well, we are only rating stuff that’s tradeable. So the volume of what’s being traded determines our actual universe.
We take whatever is being traded, whatever you can actually buy – generally bonds that have more than $250 million of volume outstanding and are tradeable in the U.S. – and we rate all of those. Then we compare our internal ratings with what the major credit-rating agencies say these bonds are worth and also with their credit worthiness.
Most of the time, as it won’t surprise you, we agree. There aren’t a lot of big discrepancies. But between 3% and 5% of the time, we disagree. Sometimes, our disagreements are big.
Devon Energy, an oil company, is a great example of where we completely disagree. We know about the quality of Devon’s asset base. They own, unfortunately, a lot of oil sands.
We suspect that their cash flows, which have been very poor for a long time, are not going to suddenly improve. S&P and Moody’s feel differently.
But we think that’s a great opportunity. It’s a place where we believe credit will have to be downgraded.
When that credit is downgraded, everything goes wrong for a company. It goes from “BBB,” which is investment-grade, down to what’s called “junk” bonds, or high-yield bonds. The cost to roll over their debts goes way up. And it also leads everybody to re-examine the quality of their collateral… which means they may not be able to roll their debts forward.
That’s really the situation we’re trying to find. Because when a corporation like that gets re-rated, the value of its equity, which sits underneath all of those debts, can get completely wiped out. If a company defaults on one bond, the value of the equity typically goes to zero.
You’re dealing with situations where a company might have $10 billion or $20 billion worth of equity. All of a sudden, they get downgraded… And investors say, “If this gets any worse, that stock could go to zero.”
So I’m not going to pay $20 billion for it today… I might not even pay $5 billion.
I want to see what happens with its credit problems. And unfortunately, when these credit problems start, they all tend to get worse at the same time. For a lot of reasons.
We can’t go into everything today, but there’s a couple of simple points that I want to leave you with.
First of all, we studied all of the corporate-debt securities. All of them. We put together what we call our “Dirty Thirty.” These are the companies who have the highest amount of equity value, but in our minds, they have the most problems with their debts.
Just one example I mentioned was Devon Energy. Let me give you another: Ford Motor.
Now, I like Ford automobiles. I drive a Ford truck. I don’t have any problems with its products. But Ford didn’t declare bankruptcy back in 2009… like GM and Chrysler did. That puts it at a grave competitive disadvantage. It’s still holding on to $130 billion worth of debt.
What you may not know is that, for all the auto sales over the last five or six years, the growth in the auto industry was powered completely by subprime leases and subprime loans. Those loans are now going bad at an alarming rate… Something like 20% of all of the subprime auto loans securitized over the last three years have defaulted.
The entire business model of selling cars to deadbeat borrowers is done. It won’t come back for another five years or so. As a result, we saw Ford’s sales decline by 8% – which was pretty shocking – year over year.
We think that’s going to continue. We think, eventually, that’s going to put pressure on Ford’s debts. Because within five years, Ford has to come up with half of $130 billion. We know it can’t do that. So whether or not Ford goes bankrupt, in our minds, is completely dependent upon the grace of its creditors.
If we end up in a default cycle, Ford is going to have a really hard time refinancing that debt. And that, of course, could see the share price go from around $12 (where it is now) to well below $5, or maybe even to zero.
So how do you speculate on that? The best way is to buy a put option. A put option is a mechanism where you can trade 100 shares for a fraction of the price. And it allows you to get tremendous leverage.
You can buy a put option right now on Ford with a strike price of $7. And if we’re right about Ford defaulting, you can make something like 20 times your money in about a year and a half.
Bill, this is why it’s a speculation… The key is it’s all about the timing. If you’re not right about when Ford’s credit comes under pressure, then you’re going to lose 100% of the money you put into the put option.
Crux note: It only took 10% of mortgages defaulting to trigger the 2008/2009 financial crisis. Today, we face a much, much bigger problem, in a much larger market. Many investors will be wiped out. But you don’t have to be a victim. Learn about this once-in-a-lifetime opportunity to make 10-20 times gains right here.