Editor’s note: Today in the Chaikin PowerFeed, we’re turning things over to a big name in the financial-newsletter industry…
Porter Stansberry is the founder of our corporate affiliate Stansberry Research. And he has a long history of prescient calls…
He accurately predicted the 1998 emerging market crisis, the 2008 financial crash, the loss of America’s AAA credit rating, and the recent banking collapses.
As regular PowerFeed readers know, we’ve been overall optimistic on stocks and the economy. But Porter sees reasons to be cautious. And it’s always good practice to listen to what smart folks on the other side of the argument are saying.
Today’s essay from Porter is adapted from a December 2022 issue of The Big Secret on Wall Street, the flagship newsletter published by his investment-research firm Porter & Co. And in it, he explains a big warning sign he sees in a specific part of the market…
The Federal Reserve – and central banks around the world – dropped rates to zero for most of the past decade…
Of course, this policy had many side effects for the market. Primarily, it pushed investors everywhere to reach for yields. Retirees were hit especially hard by this move…
The Fed removed the ability to earn safe yields from the traditional retirement income vehicle – U.S. Treasurys.
Countless retirees and other yield-starved investors had to find an alternative source of yield… So they turned to corporate debt.
As I’ll cover today, that’s how the Fed’s policies drove the rise of a dangerous investment vehicle. It has become a ticking time bomb… But no one wants to talk about it.
The days of zero-percent interest are over. And if you have money stashed in a retirement fund, it’s time to pay attention…
Through 2020, the volume of corporate bonds held in mutual funds more than tripled since the Fed dropped rates to zero during the financial crisis. Take a look…
Likewise, the reach for yield fueled an explosion in assets among corporate-bond exchange-traded funds (“ETFs”).
Regulators clamped down on reckless real estate lending in the wake of 2008. So the credit that had been created over the past decade found a new home in corporate bonds.
And instead of going through the banks, this credit was funneled through alternative avenues… like mutual funds and ETFs.
Most mutual funds and ETFs that own corporate bonds are passively managed. That means there’s no human investment manager calling the shots.
Instead, the buy and sell decisions are on autopilot. They’re dictated by a series of rules. One rule is that if a bond loses its investment-grade rating, it must be sold – no questions asked.
What could trigger such a downgrade? Any number of things. A recession might cause a decline in earnings, for example. Rising interest rates can be another trigger.
In each case, a company’s debt burden and interest expense relative to earnings would deteriorate… exceeding the threshold for an investment-grade rating.
The ultimate disaster scenario would be a one-two punch: a sharp recession caused by higher interest rates. And that’s precisely the scenario I see coming for the economy…
The massive growth in investment-grade bonds sitting at the lowest rung of the ratings ladder – now a record 60% of the investment-grade universe – could trigger an avalanche of downgrades into non-investment-grade status.
And that means one thing – fire sales.
We could see billions of dollars in sell orders come from every passively managed mutual fund and ETF that owns investment-grade corporate bonds.
Now, a fire sale in the highly liquid stock market is one thing… But it’s a different story in the corporate-bond market.
The average corporate bond trades far less frequently than stocks – depending on the issue, a few times a day to only every few days. (Less-liquid bonds can trade “by appointment,” which is rare and only if a broker happens to have both a willing seller and willing buyer.)
The problem is, holding these bonds in mutual funds and ETFs creates the illusion of liquidity. That’s because mutual funds and ETFs are set up to allow for unlimited volumes of daily trading.
But the underlying instruments in these funds – corporate bonds – don’t have sufficient liquidity to process large sell orders.
This mismatch is a ticking time bomb. If investors ever lose faith in their bond holdings and rush for the exits… or if a rash of downgrades forces the funds to dump their bonds… that bomb will explode.
The former Bank of England Governor Mark Carney once explained this fatal flaw…
These funds are built on a lie, which is that you can have daily liquidity, and that for assets that fundamentally aren’t liquid.
We got a taste of what the coming fire sale in corporate bonds will look like back in March 2020. The iShares iBoxx Investment Grade Corporate Bond Fund (LQD) – a benchmark for high-grade corporate bonds – collapsed by 22% in nine trading days. Check it out…
The situation was so dire that for the first time ever, the Fed stepped in to buy corporate bonds. But this only inflated the bubble further… After the Fed’s intervention, U.S. corporations sold a record $300 billion in debt in April 2020.
With inflation running out of control, this kind of intervention is now off the table… It won’t happen a second time.
And it’s one of the reasons why the coming fire sale will make March 2020 look like a picnic.
Regards,
Porter Stansberry
Editor’s note: Right now, Porter is out with his latest big prediction…
In short, he says that a rare type of crisis is brewing. And his warning for what’s coming goes directly against the narrative from the establishment in the financial media.
Until midnight tonight, get Porter’s game plan to prepare for this event – including how to capitalize on the situation with a specific, little-known strategy – right here.
