March 12, 2020
Today, we look to the American Consequences archives for the things that we have warned about in the pages of our magazine.
One of the biggest warning signs that we’ve watched carefully for nearly three years now –since our June 2017 launch – was the inane actions of central banks around the world and the inevitable consequences for individual investors.
Below, we feature a lightly updated article from Stansberry Research founder Porter Stansberry, originally published in July 2017.
If you’re an investor, a business owner, or a retiree concerned about the gigantic credit bubble in the market, Bizarro Capitalism is one of the most important economic concepts in America right now.
And sooner or later, it is inevitable that it will cause catastrophic problems with the world economy – perhaps even the collapse of the entire financial system.
There’s one simple way to safely protect yourself from the fallout – and even profit from the weakness in the world’s greatest credit risks.
But please don’t misunderstand us. This isn’t about “betting the farm” so that you can nail the timing of the next big market turn. Instead, it’s a way to set up a portion of your portfolio so that when the huge wave of corporate credit defaults hits, your portfolio will be well-protected – insured, if you will – against losses.
To learn more about this method – a single trade designed by a finance lawyer – and why it can hand you bigger profits than you’ve made over the past decade – click here to reserve your seat.
When the Stock Market Wakes Up, It Will Be Too Late
By Porter Stansberry
It’s one of my new favorite themes: “Bizarro Capitalism”…
To preview the conclusions, you’ll find below there’s a hidden downside to global central banks’ campaigns of endless credit expansion and zero interest rates: As capital costs disappear, so do profit margins.
Equity investors will surely cheer financial innovations that lead to rapid amounts of revenue growth. But bond investors – those dreary troglodytes – focus on cash flows. Trouble is, despite wondrous new products, massive investments in research and development, capital expenses (like plants and equipment), share buybacks, and gigantic acquisitions… most of America’s top companies aren’t producing additional cash flows. But they are producing a lot of new debts.
How will this end? That’s the question I will attempt to answer today.
Readers of a certain age may recall Bizarro Superman – the comic villain who was Superman’s polar opposite…
(Truly refined readers will recall the Seinfeld episode “Bizarro Jerry,” which adopted the same metaphor. Seinfeld’s sometimes-girlfriend tells him she has picked a new man who is the polar opposite of him, “Bizarro Jerry.”)
Bizarro Capitalism is my extension of these ideas. It means a system of exchange and property ownership where capital is free and therefore requires zero savings or profits to grow.
In theory, the costs of doing business are limited to capital and labor. Technology has greatly reduced the labor inputs for most businesses. With nearly free capital and greatly reduced labor inputs… the costs of producing a widget or providing a service have plummeted across our economy.
That sounds great, right? Lower costs should equal bigger profits. But of course, there’s also competition. When everyone has access to unlimited capital… and technology limits the per-unit cost of labor… economic theory suggests there will be a race to zero. No one will be able to make a profit because there’s no scarcity of capital, and therefore no ability to increase relative productivity.
And… what has happened?
The last several years have seen the rise of companies that are experts at exploiting technology to reduce labor costs. Free capital and zero per-unit marginal labor costs equals a whole new form of capitalism that’s genuinely unlike anything the world has ever seen before.
These are companies with massive scale, massive sales growth… and virtually zero profits.
As proof of these concepts, I pointed to Amazon (AMZN)…
Here was a company that had grown tremendously. Since 2013, the online-retail giant’s revenues soared from $80 billion to $140 billion annually. Those are huge numbers.
And profits? There aren’t any in its consumer businesses. Its corporate-services business (Amazon Web Services) makes about $1 billion a year currently.
So over the last three years, on revenues of $320 billion, Amazon made about $3 billion in profit – or less than 1% of sales. Nevertheless, it had invested an incredible $17 billion on acquisitions and capital improvements – before its $13 billion acquisition of Whole Foods Market (WFM). In total, the company has now spent $30 billion on investments in its business… almost none of which are expected to make a profit.
The stock market loves Bizarro Capitalism…
Stocks in general have virtually never been this expensive before as measured by the ratio of share prices to revenues or profits. Bizarro leaders like Amazon and Netflix (NFLX) have seen their share prices explode. When Amazon introduced the Kindle e-reader that gutted the profitability of every other book retailer, the stock was trading for around $90 a share. Roughly 10 years later, it traded for more than $1,000 a share – an increase of more than 10-fold. [Editor’s note: And of course, “Bizarro Capitalism” has only gotten crazier since Porter first wrote this… Amazon now trades for nearly $2,000 a share.]
But Amazon wasn’t just targeting book retailers. Even though online retailing today only makes up about 10% of retail sales, the price competition it has engendered makes it almost impossible to maintain a profit margin in the sector.
Finally, investors are beginning to realize the downside to Bizarro Capitalism. As you can see below, the retail sector looks like a war zone…
|Company||Ticker||January to July 2017 Performance||Performance From July 2017 to March 2020|
|Christopher & Banks||CBKC*||-46%||-75%|
|New York & Co.||NWY**||-42%||-85%|
|American Eagle Outfitters||AEO||-25%||-20%|
|*Delisted, now trades OTC
**Name changed to RTW Retailwinds (RTW)
***Acquired in 2018
This is just the beginning…
All of these stocks, and many others, will likely go bankrupt. And the recovery rates on these bonds will not be normal (around $0.45 on the dollar) because no one is going to buy these companies or their assets beyond their inventories.
But the biggest problems from Bizarro Capitalism will occur in the commodity markets. Virtually free capital has led to a huge increase in commodity production, from oil to corn.
Since July 2011, U.S. onshore crude-oil production has essentially doubled. The last time U.S. crude-oil production doubled, it took 25 years, from World War II until the mid-1960s. We’ve done it again in just six years. Corn has seen production grow by almost 50% since 2012, from 10.8 billion bushels to 15.1 billion bushels.
But what about consumption?
Since Bizarro Capitalism doesn’t require anyone to delay consumption (for savings), there’s no pent-up demand for any of this stuff. Oil and corn demand have barely grown. That’s why prices have fallen so much. Bizarro Capitalism is a recipe for collapsing profit margins (like retail). But it’s also a recipe for collapsing commodity prices. And that sounds good… until you understand more about how Bizarro Capitalism really works.
You see, even though the money doesn’t come from savings, it still has to be borrowed. And the folks who lent all of this capital don’t think of it as funny money… They think it’s real. And they’re going to want it back, with interest.
In early 2017, I pointed to Deere & Co. (DE) as a primary beneficiary (in the short term) from Bizarro Capitalism…
The tractor manufacturer had lent farmers $38 billion to buy tractors and other items necessary for farming. (That explains the huge increase to corn production.) The Wall Street Journal noticed this, too. This week, it published a well-researched article, noting that John Deere had become the fifth-largest agricultural lender in the country…[Deere] is providing more short-term credit for crop supplies such as seeds, chemicals and fertilizer, making it the No. 5 agricultural lender behind banks Wells Fargo, Rabobank, Bank of the West and Bank of America, according to the American Bankers Association.
Does that make any sense?
Should one of America’s most important manufacturing companies be inflating the demand for its products by becoming one of the largest agricultural banks in the world? Isn’t it obvious that these loans are going to lead to far too many tractors being sold, sharply lower corn prices, and, eventually, a new financial crisis in America’s heartland?
Deere, like many manufacturers in this credit cycle, has used leasing, even more than lending, to sustain demand for its products. Since 2010, the value of Deere’s outstanding leased equipment has soared, from less than $2 billion to almost $6 billion. The Wall Street Journal explained…
Deere accelerated its equipment leasing in 2014 when sales plummeted following almost a decade of rapid-fire purchases by farmers flush with cash. The leasing business has kept Deere from having to idle factories and has provided dealers with income from replacement parts and services for leased equipment.[Leases] provided farmers with machines for one to three years for a fraction of their purchase price, alleviating the need for loans. A new tractor costing $250,000 can be leased for about $30,000 a year. That compares with the cost to buy with a loan, which would require a 20% down payment of $50,000 and more than $40,000 a year in payments for five years.
Trouble is, when you provide leases for equipment that make them much cheaper to own, you make it much harder to earn a profit selling the same equipment. Deere has seen its profit margins on its equipment sales fall from $5 billion to less than $2 billion. That’s Bizarro Capitalism: plenty of revenue, but no profit.
Here’s the real trouble…
Eventually, all of those leased tractors get returned. If they can’t be sold quickly, Deere takes the loss. Over the last three years, the amount of equipment leased out by Deere is up 87%. But what have corn prices done? Nothing. So… what do you think will happen next, after three years of booming lease business and no profits from farming?
The stock market couldn’t care less about these risks. Shares of Deere have moved from around $75 to more than $120 in roughly the last year alone. [Editor’s note: DE shares are at $150 today.] And right now, the bond market couldn’t care less, either. Deere’s long-dated bond (the 5.375% bonds due in 2029) is trading for $24 over par ($124) and yielding 3%.
How will all of this end?
Will Deere successfully use virtually free money (in the form of endless supplies of credit) to prop up demand for its tractors forever? Will U.S. oil producers be able to lower their operating costs forever?
My bet is no. And sooner or later, the gigantic credit bubble that lies at the heart of Bizarro Capitalism will burst.
Of course, I can’t give you a date to put on your calendar. But keep your eye on the market for high-yield debt. The credit market will see these problems coming long before the stock market does.
And when the stock market finally wakes up to these problems, it will be too late. Volatility will return – practically overnight – and investors will panic.
Editor’s note: In the past week, volatility has returned to the market seemingly overnight, with the CBOE Volatility Index soaring to levels last seen during the global financial crisis in 2008. And according to many of the world’s best investors, the pain is only beginning…
But on Monday, March 16, you can learn why this volatility gives certain investors an incredible opportunity. You’ll learn the details of the strategy that has led to locked-in closed gains of 227%, 137%, and 126% in just the past two weeks while the market was crashing.
And you’ll also immediately receive the names of three stocks to target with this strategy, for 500% to1,000% potential gains. The event is free to watch, but we expect a massive audience. Reserve your spot now – then tune in on March 16 for details on how you can insure your portfolio and even profit during a market crash.
Now here are some of the stories we’re reading…
The 30 Minutes That Can Make or Break the Trading Day
As investors fled stocks and rushed into safe-haven assets like government bonds, sudden late-day moves in the stock market have been a staple, creating climactic swoons – and surges – right before the 4 p.m. closing bell.
The coronavirus economic ‘disaster’ scenario: Stagflation
For those unfamiliar with the term, stagflation was a major problem for the US economy in the 1970s, when there was an oil shock and surging prices for gas. The Fed chose to fight the inflation aspect more aggressively, raising interest rates as high as 20% by 1981.
Yes, There Are Libertarians in Pandemics
In short, if you had to pick any time in human history to live through a global pandemic, you’d be incredibly foolish not to pick the current time. And the reason you’d pick this moment in history probably has less to do with who is running the White House, the Centers for Disease Control and Prevention, or the World Health Organization, and more to do with the technological and medical advances made possible by free enterprise.
True number of U.S. coronavirus cases is far above official tally, scientists say
The mathematical simulation of the U.S. outbreak was run over a thousand times by a team from Cedars-Sinai Medical Center in Los Angeles and Peking University in Beijing. They began with a hypothetical group of undetected carriers – likely eight to 16 people – who arrived in the United States on direct flights from Wuhan after the virus now known as SARS-CoV-2 began infecting humans in late November but before those flights were halted on January.
Response to coronavirus could test limits of government powers
“In times of emergency – including public health emergency – the temptation to violate individual rights is at its greatest, and the courts have often been called on to defend the rights of the vulnerable,” said Harvard Law professor Glenn Cohen.
And let us know what you’re reading at [email protected].
Publisher, American Consequences
With P.J. O’Rourke and the Editorial Staff
March 12, 2020