Warning: If You Own Any of These High-Yield Investments, Sell Right Now

I worry that you’re still not paying attention…

I began warning about risks to high-yield bonds in May 2013. I knew that yields were far too low (less than 5%). I’ve frequently repeated those warnings ever since.

The high-yield credit markets, commodity stocks, energy stocks, biotech stocks, and transportation stocks have shown significant weakness.

But the real trouble lies within the credit markets… Today, for the first time ever, more than half of the cash held by U.S. corporations is invested in other corporate bonds.

[ad#Google Adsense 336×280-IA]Here’s the most important warning I can give: If you own any high-yield bonds through mutual funds or exchange-traded funds (ETFs), sell right now. Do not wait.

There’s going to be a massive crisis.

The biggest problem is liquidity. When bonds start going bad, few investors want to buy them. When a default cycle begins, people always rush to the exits.

Just a few weeks after my most explicit warnings, the exact problems I described have started to emerge.

Bond fund after bond fund is experiencing huge waves of selling pressure and, for a handful of funds already, they’re responding by erecting “gates” – making it impossible for investors to get their money out.

This is a huge problem… And trust me, it’s going to get much, much worse.

Anticipating this crisis, my team and I have been shorting leveraged financial stocks in my Investment Advisory newsletter. We’ve launched a distressed-debt research service (Stansberry’s Credit Opportunities). We hope to capitalize on the sometimes gross mispricing that can occur in distressed corporate bonds.

Please listen to me… We’re approaching a huge bear market. There’s nearly $2 trillion worth of stocks whose bonds are trading for less than $0.80 on the dollar already. All of these stocks could go to zero if these bonds default.

I know 95% of my subscribers will never understand or profit from the tremendous gains we will surely find in distressed debt over the next 18 to 36 months. It’s just too difficult for most people to take the time to learn a new market (like corporate bonds).

But… I can’t help that.

I can only help people who are ready to help themselves. You do not have to be a victim this time. You have a great, talented team of honest analysts on your side, who come to work every day and try to figure out how to educate and motivate you. Just follow our lead.

Today, I just want you to learn one thing: The key to making money during distressed markets is to generate large amounts of income.

With distressed bonds, that means getting current yields of 20% or more. With equities, that means selling puts when volatility (measured by the “VIX”, also known as the “Fear Index”) is up and premiums are rich.

Having this cash (being liquid) when the market is panicking is the whole trick. No one else will have cash. Everyone else will be panicking and frozen. You will have plenty of money to speculate.

But… which stocks should you sell puts against?

It’s a group of companies you would be happy to own anyway… but that you don’t actually plan to buy. Instead, on days when the market is falling and volatility spikes, you’re going to sell puts on these stocks. And you’re going to use a Level IV margin account, so you will only have to put up 20% of the capital for these trades.

Let me give you a real example…

Back in February 2009, the stock market had been in deep distress since the collapse of Lehman Brothers in mid-September 2008. Volatility had been elevated (at more than 20, and usually more than 30) for the entire period.

Stocks had been falling, almost every month, for a year. Finally, on February 10, the market experienced yet another genuine panic. The Dow Jones Industrial Average was in virtual freefall, down 4% on the day. For distressed investors, this was the perfect market environment. Stocks had been beaten up for months and volatility was spiking.

Tiffany (TIF) is a company we have long admired. It has one of the world’s foremost brands. It sells the highest-quality jewelry in the world – and more of it than any other company. Its profit margins are the envy of retailers.

Tiffany has fantastic retail locations and millions of repeat customers. Its balance sheet is full of gold, silver, platinum, precious stones, and real estate. What’s not on its balance sheet (at least, not fairly represented) is the incredible value of its brand. However, a year into the worst bear market since the Great Depression, Tiffany’s shares were trading for only $21.

It might be hard to understand how cheap that was. Let me explain it this way…

Ben Graham – Warren Buffett’s mentor and the longtime dean of value investing – created a formula for when to buy stocks in the midst of a crisis. This is the ultimate measure of high-quality value in stocks:

  • Assets greater than two times total liabilities
  • 10 consecutive years of profits
  • 20 years of uninterrupted dividend payments
  • Earnings growth in the past decade of at least 33%
  • A price-to-book ratio no higher than 1.5

Finding super-high-quality stocks with these value parameters is extremely rare. At the market bottom in 1991, only six stocks qualified. At the bottom in late 2002, only two stocks qualified. By early February 2009, eight stocks met this most stringent test of value… and Tiffany was one of them.

And there was a huge hole missing from Graham’s analysis: goodwill. Tiffany doesn’t carry any goodwill on its balance sheet. That means you won’t find the value of its brand or the value of its huge customer list anywhere on its financial statements.

Meanwhile, it is the brand that creates those 50%-plus gross margins. In short, buying Tiffany where it stood that day at $21 per share was one of the best opportunities I had ever seen in the stock market.

I knew it was almost impossible for Tiffany’s shares to trade lower. Someone would have bought the entire business, or Tiffany’s management would have launched a massive share-buyback campaign (and later, it did). And yet… because there was so much volatility and so much fear, even far-out-of-the-money put options were trading at high prices.

We recommended selling a put option with a $15 strike price! That strike price was 28% “out-of-the-money.” Again, in my view, it was functionally impossible for the stock to trade at that low of a price for long. I considered this put option to be 100% safe. There was no way Tiffany was going to trade for less than $15. No way. Meanwhile, we were paid $1 per share to assume that risk for 90 days. For every put contract we sold, we got $100 in cash upfront. (Each option contract represents 100 shares.)

Assuming you sold 10 contracts, you would have gotten $1,000 in cash upfront. Your “risk” was the obligation to purchase 1,000 shares of Tiffany at $15 in 90 days. Thus, measured against the capital you were potentially putting at risk ($15,000), you were going to earn more than 6.5% in 90 days. On an annualized basis, that’s far more than you’re likely to make in stocks.

And you shouldn’t have had to put up $15,000 in capital, either. With a Level IV options account, you could have used your broker’s capital to do this trade. You would have only put up $3,000 in margin. Thus, your return on margin would have been 33% in just 90 days. If there’s a better way to make money in stocks, I haven’t found it yet.

Regards,

Porter Stansberry

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Source: Growth Stock Wire