Would You Lend $1 Trillion to a Bunch of 18-Year-Olds?

Big problems in the auto market... The credit cycle continues to head south... Would you lend $1 trillion to a bunch of 18-year-olds?... Will the 'Trump Trade' bail out debtors?...

In today's Friday Digest... an update on the credit cycle...

I (Porter) know a lead sentence like that will leave me with only about five people still reading. So let me try again...

The next 18 months will see: a terrible bear market... a substantial economic recession... and a great opportunity for you to buy high-quality businesses at reasonable prices – but only if you raise cash now.

Seriously... I think we're approaching another critical nexus...

One of two things is about to happen. Either a significant restructuring of our tax code frees up billions and billions of capital currently stranded overseas and provides big incentives for U.S. corporations to invest heavily in America... or the credit cycle I've been reporting on since late 2015 is going to continue to roll over into a default cycle. That would cause a serious bear market late this year or at some point in 2018.

I realize that saying either of these events could happen doesn't help you much right now. But that's why I think prudent investors should begin to hedge at least some of their portfolios to account for the possibility of either outcome.

Today, however, I simply want to show you the most important facts behind this forecast.

Please, read this carefully. Think about what these risks mean for you and your portfolio. If you have questions, don't hesitate to send them my way: feedback@stansberryresearch.com.

Two powerful economic forces are about to collide...

The first is reversion to the mean.

Right now, large-cap U.S. stocks (represented by the benchmark S&P 500 Index) are trading at higher levels than at any other time in history, except for during the huge tech bubble of 2000. The chart below shows you the ratio between the market value of these companies and their annual sales. This "price-to-sales" ratio is one of the best ways to measure the real value (or lack of value) in the stock market because there are ways to inflate other measures, like book value ratios and earnings...

One vital point to remember, however: Just because stocks are extremely expensive compared with history doesn't mean they can't become more expensive. I don't advocate shorting individual stocks just because they're expensive in terms of their ratios. Nor do I advocate shorting markets merely because they're expensive relative to history. Valuation doesn't equal timing.

On the other hand, reversion to the mean is inevitable. Every bubble will eventually find a pin.

The second economic force I want to talk about today is likely to be the pin that bursts this big stock-market bubble...

I'm talking about debt.

Everyone loves to borrow money. Few people enjoy paying it back. Many won't.

This bull market has been powered by four important credit drivers: record levels of auto loans... record levels of student loans... record levels of corporate-bond issuance (much of it "junk")... and an unprecedented monetization of the Federal Reserve's balance sheet. As I'm sure you'll agree, these four big drivers of credit growth have now stalled. And as the credit spigot turns off and borrowers are unable to borrow more, defaults will skyrocket.

Let's start with autos...

The average new car price (about $35,000) is the highest price ever. Compared with average wages (about $50,000), cars are vastly more expensive than ever before. So how have Americans been driving record numbers of new cars? Two ways: leases and very easy credit policies.

Since 2014, we've been warning that auto-lending standards were far too loose and that rising defaults would sooner or later greatly reduce demand for new vehicles (and wreck the balance sheets of auto lenders). Were we right?

The value of auto loans that are at least 30 days in default currently totals $23 billion – up 14% in just the last year. And since 2014, the leading independent auto lender, Santander Consumer USA (SC), has seen its stock fall in half. I believe it will soon fall in half again. Or as my old friend Brian Hunt likes to say, "Those shares are going to split the hard way."

The automakers themselves have been leasing a record percentage of their new-car sales (30%). That seems great until all those cars come back to the dealers. Off-lease used-car supply has doubled since 2012 and will continue to increase by another 25% over the next two years. Banking giant Morgan Stanley believes this will cause a 50% drop in used-car prices.

Remember what happened when housing prices fell?

Lots of folks who borrowed way too much money to buy their houses decided there was no point in paying the mortgage because they were "underwater" on the loan. They mailed the bank their keys and bought a cheaper house down the street.

Just remember that record percentages of new car buyers over the last five years were subprime borrowers. Given the small down payments and the extended loan terms (up to seven years!), these buyers have never had any equity in their cars. Their cars have never been worth the loan. What do you think they'll do with those cars? They will mail back the keys and buy a cheaper used car.

An incredible 32% of all outstanding auto asset-backed securities (ABSs) issued in 2016 were "deep subprime" – up from just 5% in 2010. I guarantee we'll see the first-ever auto ABS security default. These debt instruments are currently rated "AAA" – just like the subprime mortgage bonds were. And that's why bad car loans will shake up the whole banking system.

What have the automakers said about these problems so far? Ford Motor (F) was the first to even mention the problems, saying its earnings would fall 50% this year. What did its stock do? Not much... but it will...

I'm not going to waste your time with the details behind the student-loan debacle...

Just ask yourself: Would you lend $1 trillion to a bunch of 18-year-olds?

The U.S. Department of Education makes it next to impossible to calculate an accurate default rate, but Bloomberg has sifted through the data to get a reliable picture – and it's horrifying...

Some 41.5 million Americans collectively owe nearly $1.3 trillion on their federal student loans... About one in every four borrowers is either delinquent or in default. Total indebtedness has doubled since 2009.

Navient (NAVI) handles most of the loan servicing on behalf of the Department of Education. It has also invested several hundred million dollars in packages of student loans. It's currently being sued by the government for trying to collect on student loans. Go figure.

Its stock is down by roughly half since its peak in 2015. Think it can fall in half again? Or do you think it's more likely that college students suddenly become financially responsible?

In regards to corporate lending, we've seen banks begin to reduce outstanding corporate lending for the first time since 2008...

We track corporate-default rates and corporate-debt downgrades in our trading service, Stansberry's Big Trade.

So far in 2017, we've seen 228 companies suffer a credit downgrade. That's slower than the first quarter of last year (324), but it's still more for any first quarter between 2010-2015. The high-yield "junk" bond default rate has improved a bit, too. It reached 5% in 2016 and now stands at 4.4%.

The rally in oil prices has given some companies a reprieve, but the credit cycle has certainly rolled over. Defaults and downgrades are continuing to rise.

Finally, and perhaps most important...

The Federal Reserve says it will now begin to "unwind" the $4 trillion credit stimulus it has been providing the market. That's like taking 25% of GDP out of the credit market. I'm fairly confident that won't be good for interest rates, default rates, or the stock market.

The "Trump Trade" – the big rally we've seen since the presidential election – has investors feeling confident, even euphoric. I'd certainly admit that if Trump can push through significant tax reform, it's possible this default cycle could be cut short.

Especially important is Trump's efforts to flatten the progressive nature of the tax code through a border adjustment tax (which would allow for the top marginal rate on income taxes to fall to around 30% and would allow for taxes on capital gains and dividends to fall to around 15%).

Trump's effort to change the rules on corporate taxation and depreciation schedules is also crucial. Allowing companies to expense all capital investments in full would create a significant boom in corporate spending.

But – barring some significant restructuring of the U.S. economy – investors should be looking to hedge their portfolios going into the second half of 2017. The credit problems aren't going away. They're going to get worse. It's only a matter of time before they upend the stock market.

I covered some of these ideas in the webinar I hosted with the Metropolitan Man on Wednesday evening...

Erez Kalir, my friend and CEO of Stansberry Asset Management ("SAM"), introduced me to the Metropolitan Man last year. SAM is an investment advisor using the distinctive Stansberry Research value-investing philosophy to guide investing decisions for clients with portfolios of $500,000 or more.

Erez tuned into the webinar like many of you did. Recently, Erez and his team put together a report about the Trump Era for SAM's clients. The report details SAM's views on the reasons for caution in the current investing environment, the economic implications of the 2016 election, and the investment risks and opportunities in 2017 and beyond. Erez is making this report available to Stansberry Research subscribers for free.

You can learn more about SAM's views on investing in its report, titled "Balancing Opportunities and Risk in 2017," by clicking here.

Whether or not you're interested in working with a professional investment advisor this year, this is a great opportunity to read a more in-depth perspective on investing in the Trump era.

As you know, Stansberry Research and SAM are separate businesses, both legally and operationally. We have separate ownership and management, and neither I nor anyone at Stansberry Research is involved in the day-to-day business at SAM. Similarly, SAM does not have any special or early access to our recommendations... SAM receives them at the same time as all other subscribers. See below for more important information on Stansberry Research and SAM.

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In today's mailbag, kudos – and some criticisms – for this week's big "Metropolitan Man" event. Send your notes to feedback@stansberryresearch.com. Good or bad, we read them all.

"Porter, et al, other writers will be, I'm sure, more eloquent than I. I like information, and it can be quite hard at times to get good information. Last night's conversation with [the 'Metropolitan Man'] was exceptional and excellent. You're keeping good company these days. WELL DONE!" – Paid-up subscriber Bert D.

"Awesome service to your subscribers! As per usual!... MANY THANKS for all you do. Thoroughly satisfied Alliance Member – and extremely pleased and happy to be so." – Paid-up Stansberry Alliance member Steve A.

"Dear Porter... I just finished listening to the recording of the webinar from last night. With a two-year old and a one-month old, I wasn't able to listen live. Great information from your team and really enjoyed [the Metropolitan Man's] perspective. I was fortunate enough to join Stansberry's Big Trade a few months ago as a charter member and was pleasantly surprised when my email showed the new picks..." – Paid-up subscriber Greg G.

"Dear Porter, thanks very much for that opportunity. Well worth the fee and I am eager to see Trump make his plans happen. I appreciate, as a [Stansberry's Big Trade] subscriber, the 'gift' of the Trump 12... [The Big Trade recommendations] have gained me quite a bit in a short period of time, so I was happy to get the briefing last night. Crossing my fingers for Trump – despite all the negative news about him (Is ANYBODY on his side??)!" – Paid-up subscriberhttps://ssl.gstatic.com/ui/v1/icons/mail/images/cleardot.gif Stephanie B.

"Porter, you are not going to be able to earn a negative reputation as a money grubbing newsletter publisher if you keep giving us upgrades to previously paid for products vs. making it a new newsletter to generate more Stansberry revenue. Thanks for keeping it simple for us!! It was great to hear what is really happening around the new Civil War, and how these new bills should be good for both sides to rally behind and pass.

"However, I predict that both sides of your Big Trade will work out great. I believe the Metropolitan Man is too optimistic about both sides being smart and passing these bills without first looking for ways to pound their chest trying to take simple bill ideas and creating delays while they attempt to add extra stuffing. I fear the market and its investors will have to be first drug through the swamp, before both sides can claim the rescue. However, now with the Big Trade part 2, we will make big returns during the market swamp dive with high volatility, and then when the bills are passed we will take those winnings and receive a back to back victory of huge gains as the Trump 12 plays evolve." – Paid-up subscriber Michael R.

"Dear Porter, great presentation tonight. I wish the Met. Man could have stayed a little longer for us to pick his brain some more. I hope you had a positive response with new readers signing up as well." – Paid-up subscriber Bret

"Porter, thanks for putting the briefing together. I found it both informative and enjoyable. A great example of why I chose to upgrade to Alliance..." – Paid-up Stansberry Alliance member M.T.

"I think the first hour with [the Metropolitan Man] was worth the price of admission. Interesting, but as a relatively small investor the second half was a bust. Just can't afford the price. I'll just hang with my Alliance membership as long as you let me keep it." – Paid-up Stansberry Alliance Norbert D.

"[Last night's presentation] was excellent! However, I'm finding more and more that Porter's and his team's advisories are targeted only to the large investor – the small to mid-size client can't afford to drop $5000 to actually benefit from this new offering. I'm absolutely convinced that you're on the right track regarding the Trump effect, and I've been searching for a way to approach these circumstances intelligently for the past 2 months. After getting pumped up for just under 2 hours last night, it was unbelievably disappointing to discover that I would be shut out!!

"What about the smaller investor?? Do we have to go elsewhere? I've been a loyal client for several years, and have done very well (have averaged 17%-19% annually) but I'm wondering how much longer I can actually participate when the really compelling products that Stansberry is now offering are almost completely targeted to the more wealthy among us." – Paid-up subscriber Peg L.

Porter comment: It's a fact of life... We're in business primarily to serve our wealthy clients, who finance the vast portion of our overhead. Luckily, we find these clients, primarily, by proving our mettle in low-cost newsletters. For less than $200 a year, you can read the broad ideas from my team, Sjug's team, and Doc's team. Plus, you get the Digest, DailyWealth, and the Crux – for free. That's a heck of a deal. So instead of focusing on what you can't have, maybe you should think about all of the stuff you're getting for next to nothing, thanks to our wealthy clients.

"Good job on last night's presentation, but apparently you did not convince your boss –from today's Bill Bonner's Diary: 'Our guess: The Trump administration will not drain the swamp. There will be no significant cut in taxes, regulation, entitlements, or spending. No reflation. No boom.'" – Paid-up subscriber Jim B.

Porter comment: Wouldn't be the first time I couldn't convince Bill of something. Of course, he's been bearish since 1972... when I was born.

"I, personally, was a little disappointed in [the Metropolitan Man's] presentation. As a retired person, I spend a fair amount of time reading and watching the financial news. I read the Stansberry publications thoroughly; therefore, I think I'm informed. I will be eager to get a copy of the written transcript to see what I'm missing. Thank you." – Paid-up subscriber Chuck E.

Porter comment: Really?


Porter Stansberry
Baltimore, Maryland
April 7, 2017

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