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The Weekend Edition is pulled from the daily Stansberry Digest. The Digest comes free with a subscription to any of our premium products.

Forget a Bear Market... The U.S. Financial System Is About to Be 'Reset'

By Porter Stansberry
Saturday, December 2, 2017

 Oh boy, did I set off the "boo birds"...
A week ago, I (Porter) discussed a number of troubling warning signs that are emerging and that could emerge next year. I wrote that investors should "start selling."
And that brought out the boo-birds. Here are a few of the more civil replies I received...
"Perhaps it's just a timing issue due to publication deadlines, but how do you rationalize the bearishness in Friday's Digest with this statement from Steve in Friday's issue of True Wealth? 'The great boom in stocks could continue to 2019 or even 2020. And the Fed – the usual cause of stock market crashes – should not cause the markets trouble in the near term.'" – Paid-up subscriber Chris D.
"Well Porter, you asked for it. You've been calling for the End of America, or the End of The World for a long time now. I have lost track of how many years you have been hollering 'Fire.' If you can't tell us what you recommend we do now, other than buy another subscription, could you please take a page from Dr. Steve's book and at least tell us what inning we are in, in this mess? – Paid-up subscriber Frank H.
"Bubble, no bubble... cryptos, no cryptos... park your money, bullish as hell... Blah, blah, blah. You play both sides and claim victory to whatever happens. You guys wear me out!" – Paid-up subscriber Neil C.

Lots of you pointed out that I've been bearish for a long time – which isn't exactly true. Plenty of other folks reminded me that our hedging strategy in Stansberry's Big Trade hasn't worked at all – which is certainly true. And virtually everyone wanted me to explain how I could write "start selling" at the same time that my colleague Steve Sjuggerud says the "Melt Up" will continue until 2019 or 2020.
So let me clarify what I wrote and explain what you should do about it right now.
Then let me show you why what happens to your portfolio over the next few years should be the least of your worries. Protecting your portfolio is easy. Protecting everything else won't be.
 So what's the problem?
For the first time since 2010, default rates on consumer loans are rising. This credit weakness is accompanying a general decline in transportation stocks.
These two leading indicators suggest weaker economic activity is likely next year. If this weakness continues, it could weaken gross domestic product (GDP) and earnings. Given the high premium on stocks right now, any decline in earnings could trigger a bear market (a decline of 20% or more in average stock prices).
Steve could be right. Stocks could simply continue to rise, despite deteriorating fundamentals. Stranger things have happened before.
Nevertheless, I think it's wise to start planning for your portfolio to survive a decline next year – just in case. Steve doesn't.
So we disagree. That happens frequently when people discuss their opinions about the future. It's not a conspiracy. It's just both of us trying our best to serve our customers.
 But the issue runs deeper...
If that were all this issue was about – the fact that I'm cautious about stocks and Steve is bullish – then it wouldn't be a big deal. But the problem goes beyond two guys with different opinions about the stock market.
You see... what's powering Steve's Melt Up is a gigantic credit bubble, the biggest one yet. And I believe that when it finally collapses, the damage will go way beyond economic problems and a bear market in stocks.
The signs of these far bigger problems haven't emerged – yet. As I wrote a week ago, I believe they will emerge next year. I'm talking about an inverted yield curve (if the Federal Reserve keeps raising interest rates) and soaring borrowing costs for the federal government.
These two factors are incredibly important for investors to consider carefully because they will have a profound impact on the amount of credit that's available and the cost of that credit.
As interest rates on the government's bonds increase, that debt will become more expensive, taking a larger and larger share of the government's spending. That will reduce what the government can spend elsewhere. And even more important, it will make government debt progressively more competitive with other kinds of credit, like consumer debt and corporate debt. That will make capital more expensive to borrow across our entire economy.
 Our economy hasn't seen any significant increase to capital costs since 2008...
Even the briefest increase to capital costs in late 2015 saw yields on junk bonds soar to more than 10% and caused the stock market to decline by almost 10%.
If that happens again next year, I'm absolutely certain the damage will be much, much worse.
Why? Because we're much further along in the credit cycle. An enormous amount of credit comes due in the corporate bond market between 2018 and 2020 – more than $1 trillion in speculative-grade credit alone.
 And something bigger is at stake now, too...
Our entire financial system (and our way of life) has become addicted to cheap and ever-expanding credit.
Since September 2010, when nonmortgage consumer credit bottomed at $2.5 trillion, it has rebounded at its fastest pace ever. Today, Americans owe $3.7 trillion in outstanding consumer credit. That's $1.2 trillion of additional consumer spending, created out of thin air (not savings) in just eight years.
During the same period, the federal government increased its debt from $14 trillion to more than $20 trillion. Just think about that number... Our government borrowed an additional $6 trillion in less than a decade.
Does that seem wise?
Does that seem sustainable?
What do you think will happen when these debts come due?
What do you think will happen when the people who depend on government transfer payments realize there's nothing behind the "curtain" except for a bankrupt old wizard?
And how long do you think those tax cuts are going to last (if they are even passed) if our government's borrowing costs soar?
Finally, while individuals and our government have been on an unprecedented borrowing and spending binge, corporations, which have been offered unlimited amounts of essentially free capital, have also been borrowing and spending like never before. Total outstanding nonfinancial corporate debt has doubled since 2005, from around $3 trillion to more than $6 trillion, with most of the growth coming from noninvestment-grade borrowers.
Like our government, corporations have borrowed more in the last decade than ever before – more than a 100 years' worth of debt has been issued. And almost all of it went to either buying other companies or buying back shares.
Does that seem wise?
When you put all of these numbers together, you'll see that we've borrowed something on the order of $20 trillion in just the last eight years. That's more than our entire GDP!
 So... what happened?
Stocks have gone way up. (Shocker.) Look at how much borrowed money was used to fund share buybacks.
Bonds have gone way up. (Shocker.) The Federal Reserve printed $3 trillion and manipulated interest rates to essentially zero. Other central banks around the world followed... pushing rates lower and lower... and in some cases, below zero.
All of this debt and manipulation caused demand for financial assets to go bonkers. This demand has reached a never-seen-before level so high that an unknown computer programmer successfully created a new financial asset: cryptocurrency.
It's a currency without an issuing country and a tax base. It offers investors precisely nothing. It's like paper money, without the paper. It's not an "IOU nothing" like the dollar, the pound, or the euro. It's a "who owes you nothing"... And this cryptocurrency asset class is now worth almost $200 billion.
Does that seem wise?
But what about real economic growth? What about real increases to wages? What about gains in our standard of living?
Well, despite this enormous tidal wave of debt and spending, Barack Obama was the first president to ever witness a complete term in office without even a single year of growth in excess of 3%. Wages, in real terms, haven't budged.
And you know why that didn't happen: The money wasn't earned. It's not real. And it wasn't invested in expanding our productive capacity (in most cases). It was spent on financial assets. It was spent on consumer items and wars.
Some of our subscribers are upset or confused because they believe we're not offering them a consistent view of the world. It has never occurred to them that the forces driving Steve's Melt Up thesis are the same exact forces that I'm writing about here.
Steve sees the massive boom all of this new money and credit has created. He has done a brilliant job showing our subscribers how to take advantage of it.
 I'm focused on what these obligations will do to our markets and our country in the long term...
But that doesn't mean I haven't helped a lot of people do well during the bubble, too. Folks who say I'm bearish must not have read any of my newsletters over the last decade. I've been 90% long and have recommended a slew of our biggest winners, including both e-commerce firm Shopify (SHOP) and online retailer Overstock (OSTK).
So please... don't pretend that you can't both consider the risks we face and make money while the sun shines.
Anyone who wants a universal, coherent view of how to order their affairs in light of these risks and opportunities can simply review The Total Portfolio in our Stansberry Portfolio Solutions product.
I manage The Total Portfolio. Look there and you can see exactly what "start selling" means for investors.
We've put a lot of capital into precious metals and short positions. We've increased our cash position. And we own a lot of safe, "ride the storm out," fixed-income investments. We've also sold down some of our big winners.
This has cost us a little bit in terms of total return. We're now trailing the stock market by maybe a percentage point. But we're still making great returns for investors, with far, far less risk and volatility.
So if you're looking for a solution, there it is. It's all right there in black and white.
But heck, what fun is that?
If we told you exactly what to do, down to the number of shares to buy in each position – and if that portfolio kept pace with a roaring bull market, while keeping about 40% of the portfolio in either fixed income, hedges, or outright short positions – then what could you complain about when I write such scary warnings about the future?
You'd think of something, I'm sure.
 You're not getting it...
Look, friends... you're sitting there thinking about your portfolio. You're worried about your money... worried about earning a return... worried about keeping pace with your neighbors... worried about leaving something for your kids.
But you're asking all of the wrong damn questions.
By a mile.
You aren't getting it, even though you just read the essay I wrote a week ago... And even though you're reading this right now. You just aren't getting it.
I didn't write that essay to get you prepared for a bear market. A bear market is nothing. It's no big deal. If you follow your stops and you're hedged at all, you'll be fine. The downturns we saw in 2000-2002 in tech stocks and 2008-2009 in most stocks were as bad as bear markets get.
We survived both, handily, in my newsletter. We made money in 2002 by shorting. And we broke even in 2008 by shorting and buying near the bottom. We can handle a bear market. It's no big deal. A bump in the road for most people, a great buying opportunity for some.
If those bear markets hurt you, it's probably because you were far too concentrated in a few risky stocks. Just don't make that mistake again and you'll learn not to fear bear markets at all.
It's not an eventual bear market in stocks that I'm writing about.
It's something like you've never seen before. You've never seen what happens when millions of people can't possibly pay their bills. When thousands of companies can't refinance their debts. When confidence in our financial system, our government, and our way of life evaporates overnight.
I'm not talking about a bear market. I'm talking about a complete "reset" of our financial system. It's the only way forward – the debts we've racked up over the last decade can't possibly be repaid.
Did you read what I wrote above? We've borrowed $20 trillion in less than a decade.
We've spent the money on a bunch of stupid stuff – wars, share buybacks, worthless college degrees, inflated medical care, and lots and lots of drugs.
The bill is coming due. And there's no way it can be paid back.
So whose pound of flesh is going to be roasted? That's the question you should be asking.
By the way, we'll begin to see all kinds of other warning signs. Rising short-term interest rates and an inverted yield curve? That's nothing compared to what else is going to happen next year.
Think about big defaults on consumer-loan securitizations hitting at the same time the corporate high-yield market freezes up because no credit is available for noninvestment-grade borrowers. That's what's going to happen.
How do I know? Just look at the numbers: U.S. speculative-grade companies owe $1 trillion before 2021. There's zero chance this debt can be paid off or refinanced if there's an inverted yield curve.
And that's why all of those firms are scrambling right now to finance these debts.
Just watch the current efforts by hospital owner Community Health Systems (CYH) to avoid defaulting on its $15 billion debt load. And remember, the company has no significant maturities until late 2019.
Think about that.
When businesses that own assets as highly regulated and noncyclical as hospitals can't get new funding, what will happen to real free-market companies with declining sales and huge debts? Just imagine.
As my friend Grant Williams, who writes the financial newsletter Things That Make You Go Hmmm, did a great job explaining... We've been living in a world of pure imagination.
Just about everything seems great when you're in the midst of spending $20 trillion worth of "funny money." But how do you think it's going to feel when we have to pay it back?
The whole structure will come unraveled because we can't possibly maintain the current value of financial assets.
But you don't have to believe me... Just watch.
Good investing,
Porter Stansberry

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