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Porter Stansberry: My most serious market warning to date

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From Porter Stansberry, Editor, Stansberry Digest:

Friends, this is a difficult Digest for me (Porter Stansberry) to write…

Nobody likes to read bad news. But there are serious problems in the underlying fundamentals of our equity and credit markets. Rising interest rates are going to expose these problems, accelerating the inevitable end to the current credit cycle and this bull market in stocks.

I am more and more convinced that the next several years will be extremely difficult for most equity and bond investors.

I’m very worried that you are overexposed to these risks.

Please. Please. Please. Read this Digest carefully.

I don’t care whether you agree with me. What matters to me is that you get a complete and detailed warning about the serious risks that exist just below the surface in our equity markets. How much risk you continue to take is, of course, up to you. But unless you understand these risks, you can’t make informed decisions. And I doubt anyone else will be able to give you the information I detailed below.

(By the way, you have my permission to share this week’s Digest with anyone you think should be aware of these problems. I hope some of your friends will choose to subscribe. But even if no one does, I still believe this information should be widely known among all investors.)

What’s the big problem?

The extremely low interest rate regime of the last decade (created by the Federal Reserve manipulating the credit markets) encouraged many companies that should have failed to continue to borrow money. As a result, there are now several hundred publicly traded corporations that cannot possibly repay their debts. These zombie companies cannot even afford their artificially low interest rates.

Several hundred American companies are destined for bankruptcy or are on the verge of it. The stock market hasn’t factored in these problems, at all.

Nobody has paid much attention to these zombie companies yet, not even when major companies like toy retailer Toys “R” Us, suddenly liquidated. (When is the last time you can remember a major U.S.-brand being liquated? Not just bankrupt, but every last item being sold off at an auction?)

The market is going to focus more and more of these zombie companies for one simple reason: Interest rates are, for the first time in almost a decade, rapidly increasing. The interest rate on the 10-year U.S. Treasury note has been going up for almost a year and recently broke past 3%. This is a key level, and it implies grave danger lies ahead for highly indebted firms. Many companies cannot refinance their debts at these levels.

I’ve included a list of the biggest zombie companies below.

So if you do nothing else, read what I’ve written below. Learn what indicators will appear as the credit cycle rolls over. Know what stocks to avoid at all costs. I’ll show you 10 of them in this Digest essay…

About the problems in the markets…

Our equity and credit markets suffer from serious, fundamental problems. These problems are big enough that I’m growing increasingly concerned that future investment returns, in both stocks and bonds, will be extremely poor.

The heart of the problem is, far too many American corporations have borrowed more money than they can possibly afford to repay.

Here’s an example of what I’m talking about…

General Electric (GE) was, at one time (the early 2000s) the most valuable corporation in the world. It manufactured everything from light bulbs to jet engines. It was essentially a corporate version of America itself. The financial excesses of the past 30 years crippled this business. Its managers engaged in every kind of accounting and financial hijinks you can imagine. They left this iconic American company saddled with more than $60 billion in net long-term debt. (Please note: That’s net debt – after subtracting all of GE’s cash.) Even with record-low interest rates, GE still faces interest obligations of almost $3 billion per year.

And here’s the problem: These interest rates are likely to rise a lot faster than GE’s ability to grow earnings. Currently, GE earns only $3.6 billion year, when measured by “EBIT” – that’s earnings before interest and taxes. If its interest expenses grow and its earnings don’t keep up, GE will have a difficult time paying its debts in its current structure.

And don’t forget, GE requires at least $7 billion a year in capital investments (capex) to maintain its facilities and position its businesses for future growth. In other words, while GE can do some things to avoid bankruptcy (like cutting its annual capex spending), it isn’t earning enough capital to finance both its debts and future growth. It is caught in a death spiral.

GE’s problems are now well known to investors because last year the company’s new CEO came forward and told everyone what had really been going on in the company. (We’d been reporting on GE’s weak financial position for years.) You can see what happened to the company’s stock price as these balance sheet issues became clear to the market.

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Yes, GE is only one company…

And it’s not as important as it used to be. But the business still has a $125 billion market cap. It employs nearly 300,000 people. GE’s troubles are going to matter, to both the markets and our economy. And unfortunately, GE isn’t the only big problem that’s lurking. Let me show you what I mean.

My friend Jim Grant, publisher of Grant’s Interest Rate Observer, recently published some research done by Bianco Research on the overall level of debt in the U.S. equity market. Bianco wanted to know how many more GEs (giant companies hugely encumbered by debt) were out there. So it asked a simple question. Based on the three-year average of cash earnings (defined by EBIT), how many U.S. firms can’t afford their debt service? Bianco found 14.6% of the S&P Composite 1500 (the 1,500 largest public companies in the U.S.) couldn’t afford the interest on their outstanding debts. That is, the three-year average cash earnings (EBIT) wasn’t big enough to cover their interest expense.

I don’t believe one in 100 American investors understands how big of a role new debt has played in the equity boom that we’ve seen over the last several years. Today, corporate debt in America is a new all-time high. American companies have never held so much debt relative to the size of our economy ever before.

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What do you think is going to happen if interest rates keep rising (which seems likely) or a recession hits?

Sooner or later, in one way or another, these problems will become clear to more and more investors – just like GE’s problems came to light over the last year. There will be catastrophic losses, unlike anything you’ve ever seen before. How do I know?

At the peak of the last big equity market bubble (2007), only 5.7% of America’s companies were in the same dire straits. That is, back in 2007, only 5.7% of America’s top 1,500 companies weren’t earning enough to cover their interest payments. The resulting bear market saw stock prices fall by 50% and led to a national bailout of the banking system. What will happen this time, when almost three times as many companies are in this critical financial position?

Here’s the part to remember…

I asked our analysts to put together a list of the 10 worst examples of big companies with horrible underlying fundamentals.

The list is below. Note, GE is in the best position. GE is still earning enough to afford its interest, but only just barely. The other companies on this list don’t make enough money to afford their current interest payments. Some of them wouldn’t make enough to afford their interest payments even if their earnings doubled (Sprint, SeaWorld Entertainment, Endurance International).

Keep in mind, these firms are only a small sample of the full problem in terms of the number of companies…

More than 100 major companies are in this poor financial condition. But my sample list isn’t small in terms of capital. These companies, collectively, represent almost $200 billion in market value. They hold $126 billion in debt, which costs $6.9 billion a year to service. That’s a 5.5% annual interest rate, collectively, for companies that aren’t creditworthy in any rational sense of the word.

With 10-year U.S. Treasury notes now paying 3% annually, who in the world is going to continue to finance these debts at less than 6% annually? No one. What about 8% annually? Doubt it. What about 10% annually? Maybe. But explain how these companies can afford higher interest rates (almost double what they’re paying now) when they can’t make ends meet at 5%? It won’t happen.

What will happen?

I don’t know. But what I do know is that investors in these stocks, and in a whole bunch more like them, are destined for severe disappointment. And that doesn’t bode well for investor sentiment, the market multiple, or the general level of the stock market.

What’s the most dangerous thing in the world to an aging bull market, made up of firms with a record-high level of debt? Rising interest rates. What do we see in the market today? Rising interest rates.

Horse, meet water.

Time is running out…

I use these pages (and my own newsletter’s recommended list) to educate, cajole, threaten, and bully people into doing smarter and safer things with their money. How many times have you seen me write “There’s no such thing as teaching, there’s only learning”? And how many times have I written “Horse, meet water”? How many times have you seen me essentially berate our customers, telling them “I know you won’t ever do this, no matter how obvious it is that you should“?

I don’t know how many people actually learn anything or how many people take my warnings seriously. What I do know is, ironically, our business tends to sell more subscriptions when investors are excited and doing a lot of risky (i.e., dumb) things with their money. And virtually every time investors get excited, a lot of people lose money. That’s what happened in the Internet stock bubble of 2000. That’s what happened in the real estate/commodity bubble of 2008. And that’s what happened – in a truly astounding way – during the bitcoin bubble last fall.

I know, this cycle is going to repeat. I just don’t know exactly when. But I’m praying that this time is different for our subscribers. Please listen to me. Time is running out on this bull market. You don’t need to sell everything, but lower your exposure to the equity markets to less than 60% of your portfolio. Put some of your capital some place safe. Buy some gold. Buy very safe bonds. Buy some local real estate that you know well and can always rent. Get out of debt. Follow your trailing stops. Raise cash when you stop out. Realize that over the next 12-36 months, the investors who win will be the ones who survive. You can choose to be one of them. You really can. But you need to act now.

I mentioned a few triggers to watch for…

The most important indicators and warnings will come from the corporate-bond market. The three most important indicators are:

  • The prices of junk bonds. As credit tightens, the prices of junk bonds will fall. You can watch junk-bond funds – like the Shares iBoxx $ High Yield Corporate Bond Fund (HYG) – to monitor these prices.
  • The interest rate “spread” between high yield debt and U.S. Treasury securities. As defaults grow, the increased risk will be expressed in much higher interest rates for weak borrowers.
  • The 10-year U.S. Treasury yield. If safe yields on government bonds reach 4% or more, there will be complete carnage in the corporate-bond market, where average rates to refinance outstanding debts will probably double.

We cover all of these fixed-income market indicators closely in our Stansberry’s Credit Opportunities service. And just so you know, default rates right now are near all-time lows. Nobody is afraid – yet.

I’ll do my best to keep you up to date as the default rate grows. For now, I’m looking for more situations like Toys “R” Us, where radically overleveraged, private-equity managed businesses fail because they’re simply denied any additional credit. That’s what’s going to happen… more and more often… until one of these deals blows up and triggers a general panic.

If I could tell you exactly when, I would. But there’s no doubt it’s coming.

Beat the rush. Prepare now.


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Why artificial intelligence is the future of investing

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From Richard Smith, Founder, TradeStops:

Artificial intelligence — and “deep learning,” a specific form of artificial intelligence — is changing the face of investing.

This is not something that will happen in the future. It is already happening. The changes are widespread and they will only intensify in the coming years.

This could be seen as good or bad news, depending on how you look at it. Artificial intelligence, or AI, is a powerful form of technology that is brand new to most people. That makes it frightening as well as exciting.

There is also a lot of hype surrounding AI, including overblown predictions of what artificial intelligence will do (and what science will be able to achieve). Sometimes it’s hard to separate the reality from the fantasy — and some have a vested interest in drumming up fear and worry.

The good news is that AI, through a technique known as “deep learning,” will be an incredible resource for individual investors. The widespread availability of low-cost computing power and increasingly powerful software programs means that the benefits of AI will ultimately flow to Main Street, and not just Wall Street or Silicon Valley.

And yet, when you hear about artificial intelligence in the news these days, it is often attached to a big prediction or a slightly ominous sounding breakthrough. For example, a London-based artificial intelligence company called DeepMind — which is owned by Alphabet, the parent company of Google — recently announced an “intuition” breakthrough in one of its game-playing AI programs.

AlphaZero, a descendant of DeepMind’s AlphaGo, is an AI machine that shows human-like creativity in games like chess and shogi (Japanese chess).

Human grandmasters, like the world-famous Garry Kasparov, have confirmed the surprising degree of “creativity” in AlphaZero’s style of play, with a willingness to take risks and make bold, unconventional moves that feel more human than machine-like.

The gameplay, however, is just a means of testing capabilities and generating publicity. The goal of DeepMind is not to design an ever-more-impressive roster of game-playing machines, but to tackle tricky and lucrative real-world problems, like the development of pharmaceutical drugs.

In the pharma world, for example, predicting the three-dimensional structure of proteins — also known as “protein folding” — is an important area where DeepMind hopes to apply deep learning techniques.

Protein structures are at the core of many life-saving drugs. If you count up all the seconds that have ticked by since the universe began, there are more potential protein-folding combinations than that very large number.

That makes the design of new protein-based drugs very challenging, and an area where an AI program — like a pharmaceutical version of AlphaZero — could accelerate the process by orders of magnitude.

It’s important, though, to clarify what is not going to happen.

AlphaZero is not close to “awareness” or “consciousness” or anything resembling human brain activity. And in fact, this particular area of AI is widely hyped and overblown.

Broadly speaking there are two types of artificial intelligence: narrow and general.

“Narrow AI” is focused on a very specific task. It is far more like a software program than anything else. The much more ambitious “general AI” is the notion of computer code achieving something like human consciousness.

Narrow AI is already here. You see it in all kinds of places, and likely make use of it multiple times without realizing it on any given day.

Narrow AI does things like auto-complete the text you type into your smartphone, translate a foreign language web page, or give suggestions for restaurants or coffee shops based on your GPS location. It does very specific things, typically by parsing large amounts of data in real-time.

General AI only exists in Hollywood movies. It is the computer that is supposedly smarter than a million humans, or the army of terminator droids trying to wipe out humanity.

A handful of experts think General AI could arrive in a decade. But those are extreme outliers. A far higher number of experts think General AI — a sort of computer-based consciousness, or a program smart enough to have awareness — could take 50 to 100 years, or in fact may never arrive at all.

In spite of the fact that smart speakers like Alexa can mimic a conversation, conscious AI is nowhere close to being achieved, and may not even be possible.

The current AI techniques being deployed aren’t in the same ballpark as General AI. They aren’t even the same sport. We may actually be closer to reaching Mars, or even colonizing Mars, than we are to any kind of substantial General AI breakthrough. That’s how big the Narrow vs. General gap is.

So, even though DeepMind as a company talks about its AI having “intuition,” we shouldn’t confuse that with any kind of march toward human consciousness. It is possible for an AI program to show what appears to be creativity, and to be useful in all kinds of powerful ways, without being conscious at all.

This is what “deep learning,” a specific type of artificial intelligence, is all about — helping human researchers (and investors) become more powerful in various ways.

Deep learning relies on “neural networks.” Because of this, the claim is that deep learning, as a technique, mimics the structure of the human brain. This is far from true.

It sounds sexy to suggest that AI mimics the human brain, because it implies that, if you go along this path far enough, you get consciousness.

The reality is far more basic, but still fascinating. It is possible to exploit the power of “neural networks” without trying to copy the human brain at all, except in a super-abstract way, and that is what deep learning does.

The “neural” part means storing information as a network of nodes, with recognition capabilities — the program’s version of awareness — distributed across multiple nodes, rather than residing in any one place like a text file.

To understand how deep learning works, imagine you come from a far-off land where there are no housecats. You have never seen a housecat before, or a cat of any kind.

Traveling to the United States, your host wants to teach you what a cat is. But instead of describing a housecat, or introducing you to a live one, they show you pictures of housecats.

After a while, in order to test your knowledge, your host starts showing you thousands of pictures, some of them with housecats and many of them without.

You make guesses as to which picture contains a housecat and which doesn’t. With each guess you get feedback — “correct” or “incorrect” — and over time your guesses improve.

Eventually, sticking at this for long enough, you have a pretty good sense of what a housecat looks like, thanks to huge volumes of trial and error.

Deep learning as an AI technique essentially does the same thing.

A computer program is taught to identify a pattern — like, say, the shape of a cat in a picture.

The program tries to “guess” at the pattern, over and over, getting feedback each time. After hundreds of thousands or even millions of guesses, the program has a pretty good sense of what a cat looks like.

This methodology requires huge volumes of data for the program to train itself. That is why giant tech companies like Google, Amazon and Alibaba have such an edge in these areas — nobody else has access to oceans of data like they do.

But again, this brute-force means of recognizing patterns within patterns is nowhere near human consciousness. It is a million miles away from it.

And yet this deep learning technique is extremely valuable, because AI-powered software can:

  • Detect data patterns that are very subtle and complex
  • Sift through huge mountains of data (find needles in a haystack)
  • Get better at pattern-spotting through testing and feedback
  • Identify useful or valuable patterns instantly and in real-time

And that, in turn, explains why deep learning is the future of investing.

In the hands of regular investors, artificial intelligence tools can scan vast quantities of data to identify useful and important patterns via deep learning techniques. Investors can then use those patterns to make better investment choices.

A key point here is that, from an investing perspective at least, the human being does not get replaced. Human behavior still plays a key role. Human decision-making and human emotion are still big factors.

But software with AI-like capabilities, enabled by powerful deep learning algorithms, can serve as an investor’s eyes and ears.

The software can scan thousands of stocks in real time — something a human can’t do. The software can also look for subtle patterns in the investor’s own behavior and investment record, and make possible suggestions for improvement. These capabilities, and more, make the investor more capable and powerful — and potentially more successful.

Those ideas just scratch the surface. The point is that, while artificial intelligence is a big, complex topic that is both exciting and a little frightening, the dawn of AI — via deep learning — is opening up a world of new possibilities for individual investors.

And this AI investment revolution, so to speak, is truly democratic because the barriers to entry are low and falling. With each passing month, if not each passing day, chips get cheaper and investment software gets more powerful.

That means you won’t have to be a Silicon Valley tech titan or a rich hedge fund mogul to utilize AI-powered software. We can be certain about this because our mission and vision, as a software company, is to empower individual investors.

It’s our bread and butter, and we can’t wait to show you what’s in store for 2019.

Richard

Crux note: More than 25,000 investors are using TradeStops to help manage risk in their portfolios. Try it for yourself today with a one-month free trial.  


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Cramer’s charts signal a potential bottom for the major averages

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The stock market’s recent swings might not be as bad as investors think, especially when stacked against their historical performance, technical expert Rob Moreno told CNBC’s Jim Cramer on Tuesday.

After consulting the charts of the major averages, Moreno, the publisher of RightViewTrading.com and Cramer’s colleague at RealMoney.com, concluded that stocks are in a consolidation phase, trying to digest the gains from a multi-year bull market.

And “the charts, as interpreted by Rob Moreno, suggest that the averages are trying to bottom here in preparation for a nice rebound,” Cramer, host of “Mad Money,” told investors.

Cramer pointed out that since the end of the financial crisis, the averages have climbed steadily higher. The Dow Jones Industrial Average, for one, bottomed at roughly 6,500 in March 2009 and has since traded above 24,000.

But this consolidation period is atypical, Cramer admitted. Normally, times like these “tend to be sedate [and] fairly limited” when it comes to trading; this one has been much more volatile, or prone to big swings, he said.

According to Moreno, “the best way to navigate your way through it is by taking a wider view of the landscape, because that’s the only way you can get enough … perspective that you won’t panic,” Cramer said. “Sure, the decline’s been brutal, but he says we’ve been through previous consolidation periods that were even more volatile and they didn’t derail the bull.”

First, Cramer turned to Moreno’s logarithmic chart of the Nasdaq Composite index. Technicians use logarithmic charts, which measure percentage moves rather than basis points, to compare market action over long periods of time.

“Moreno points out that in 2010, 2011 [and] 2015, there were periods of consolidation that had even wider ranges than the one we’re experiencing now,” Cramer said. “Even though the Nasdaq’s lost a lot of points here, on a percentage basis, the 16 percent decline [from its October highs to its November lows] is smaller than 2010, 2011 or 2015, and each of those times, the market ultimately rebounded phenomenally.”

Moreno also noted the major averages’ floors of support and ceilings of resistance, key levels that technicians watch to know when a given index or stock might change course.

The weekly chart of the S&P 500 showed a ceiling of resistance at 2,800 and a floor of support between 2,550 and 2,600, a range in which that index has been stuck all year. The Dow’s weekly chart had a ceiling at 26,000 and a floor between 23,500 and 24,000, not far below where the Dow was trading on Tuesday.

“In Moreno’s eyes, it looks like the Dow and the S&P are both trying to hammer out a bottom,” Cramer said. As for the Nasdaq, which is trading in the middle of its range, “Moreno wants to see what’s known as a hammer candle, where … the Nasdaq rallies and closes on Friday near its highs for the week. That would send a signal that the bottom will hold and perhaps we could rebound back to the high end of the range.”

The best part — at least for investors who believe Moreno’s call that this isn’t a bear market, but a consolidation phase — was that even if the averages fall below their floors of support, this is likely still a buying opportunity, Cramer said.

“If you have conviction, you might want to do some buying, seeing as the major averages are all pretty close to their floors of support, and even if these floors are violated, Moreno doesn’t think we’ll have a whole lot more downside,” he said.

Moreno added that buyers should watch for what’s called an eveningstar candle pattern to make their move: in short, it’s a three-day phenomenon when the market rallies for a day, maintains a tight trading range the next day, and then sees an unusually negative trading session.

All in all, “Moreno thinks that the situation might not be as bad as it seems,” Cramer said. “This all sounds a little too sanguine for me given everything that’s going on, but you know what? I think it’s heartening to put these declines in a more constructive perspective.”



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FAANG stocks turn red: What to buy when the market goes nuts

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From Jeff Clark, Editor, Delta Report

According to the efficient market hypothesis, there’s nothing insane going on in the stock market. Stock prices reflect all of the currently available information and investors’ analysis of that information.

Hogwash.

In the long term, I’ll agree that markets are efficient. Investors are rational. And stock prices generally end up where they are logically supposed to.

In the short term, though, the market is nuts.

In the short term, stock prices react to emotion, not logic. Fear and greed are more powerful in the short term than a thoughtful analysis of balance sheets and income statements. That’s why crazy things sometimes happen in the stock market.

Back in 2000, for example, any rational person could see the dot-com bubble inflating. Stocks with no earnings, no revenue, and no hope of either were pressing higher nearly every day. Meanwhile, traditional businesses – with long track records of earnings growth, stable dividends, and long-term business prospects – couldn’t catch a bid.

In 2000, I did not own a single dot-com stock. Instead, my largest holding was Cooper Tire & Rubber (CTB). At the time, CTB was an 87-year-old company. When I started buying the stock in early 2000 at $9 per share, CTB traded at six times earnings and paid a better than 5% dividend.

CTB promptly dropped to $6 per share.

The stock lost 33% of its value in early 2000, at a time when the average dot-com stock was racing to the moon.

As you might imagine, the clients at my brokerage firm were frustrated. Their friends and neighbors were bragging about the piles of money they were making in this.com and that.com. Meanwhile, my clients were stuck in a dusty, old, tire and rubber stock that just seemed to fall every… single… day.

All I could do to console my customers was to tell them that sometimes the markets do screwy things. Sometimes, logic takes a vacation. Stocks that shouldn’t go up, do. Stocks that should rally, don’t.

And it is during those times that investors who have the ability to curtail their emotions also have the ability to make outsized gains. But, you can only make those gains by going against the emotions of fear and greed… and betting on logic instead.

I lost several clients in early 2000. I refused to buy the dot-com stocks. I stuck with buying old, time-tested companies trading at steep discounts to their historic valuations.

By early 2002, most of the dot-com stocks had crashed and burned. The customers who stuck with me were cashing out their Cooper Tire & Rubber trade for a 150% gain.

Here’s my point…

While the focus in my Delta Report trading service is on shorter-term trading – where we attempt to get into a position one day and get out of it a few days later – there are times in the market where it can be far more profitable to take a slightly longer-term view.

Investors’ short-term emotions have decoupled from longer-term logic. So, asset prices have, for lack of a more sophisticated term, gotten out of whack.

It is during these times that it can be HUGELY profitable to take a BIG SWING.

Find a stock that is grossly undervalued by almost every fundamental metric. Find a stock that just can’t seem to get off the mat. Find a stock that nobody likes… a stock that if you mention it at a cocktail party, you end up drinking alone.

Then, buy that stock and hold it for a few months.

You won’t be disappointed.

Best regards and good trading,

Jeff Clark

P.S. Like I mentioned above, the focus in my Delta Report trading service is on shorter-term trading. It’s all about how to maximize your profits while still reducing risk.

The Wall Street players lose a lot of money because they’re always looking for that big swing moment. Though those moments do exist, they aren’t common. My risk-reducing methods have proven that you can make a lot of money while not betting the farm on every trade.

You can read more about my proven trading philosophy right here.


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