Editor’s Note: This week, we’ve featured longtime PBRG friend Porter Stansberry’s insights on what he views as a historic bond market mania setting up his ultimate “Big Trade.”
In today’s Daily, Porter continues on this theme by exploring the “primal” causes behind the most powerful changes in the financial markets… including the critical period we’re entering now (originally published in the November 8 edition of The Stansberry Digest).
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From Porter Stansberry, founder, Stanberry Research: Today, the leading car-rental business in the world, Hertz (HTZ), saw its share price fall more than 50% in the first few hours of trading. The collapse erased more than $2 billion from the accounts of some of the world’s best investors, including Carl Icahn, who owns more than 12 million shares.
Meanwhile, we’ve been warning investors about the consequences of an unsustainable debt bubble in the auto industry since 2014. Last month, we showed the subscribers of our flagship newsletter, Stansberry’s Investment Advisory, why car-rental companies are sure to collapse in a matter of months, as the auto-finance complex collapses under the weight of the industry’s bad subprime loans. We recommended shorting both Hertz and Avis (CAR), a move which has led to huge profits in only a month.
While some of the best investors in the world got hurt by changes they never saw coming in the credit markets, many of our subscribers saw their portfolios increase in value by huge amounts.
This is only the latest example of how our understanding of the credit markets greatly increases our ability to guide investors in the equity market.
These credit trends are by far the most powerful force in the stock market. Ironically, however, they’re largely invisible to virtually all investors—even the most sophisticated.
Get Ready
Over the next week, you’re going to learn more about the underlying structure of our financial markets than you ever knew existed.
You’re going to understand—maybe for the first time ever—what really causes the most powerful changes in the financial markets.
I (Porter) am talking about the trends that overthrow the existing order, that move bull markets into bear markets, and vice versa. I’m talking about the kind of massive market moves you can “feel” coming… but that maybe you’ve never been able to fully explain, or put your finger on.
Trust me, it’s not about lines on a chart. Or the earnings announcements that the media seems to believe drive the markets higher or lower.
A much more powerful, more “primal” force controls the stock market during critical periods, like the one we’re entering now. And I’m going to explain it all to you… for free.
You Can Make a Fortune
If you read the next seven Digests carefully, you won’t need to buy anything from us to make a fortune in the markets over the next three years. We’ll give you everything you need to know—in black and white. You can even print off a copy and refer to this guide as often as you like.
Yes, we’re hosting a webinar, too, which you can sign up for right here. It’s scheduled for next Wednesday, November 16, at 8 p.m. Eastern time. We will review this material and we’ll go over a few case studies—examples of our strategies that are happening in real time. (As you’ll see below, we’re going to do the same in today’s Digest.) We’ll also answer as many questions as we can in two hours.
But again, you won’t have to pay a penny. The webinar is free.
You will, of course, have to be the final judge of what this information is worth, but I know most people pay $100,000 or more to acquire this kind of knowledge in master’s programs or CFA studies. You can get it for free… and in a fraction of the time normally required.
Your Only Commitment
But you will have to commit your time over the next week. It will be fun—really. What we’re going to teach you is just common sense dressed up in a lot of financial jargon. And as you understand that, more and more… as the picture becomes clearer and clearer… you’re going to feel much more confident about what you’re doing in the markets.
I bet that for the first time ever, you won’t feel anxious about what might happen to your savings. Instead, you’ll be excited about what’s going to happen next because you’ll know why it’s going to happen.
One Word of Warning
As we always tell our subscribers: There’s no such thing as teaching, only learning. What we mean is, no matter how valuable the information we’re giving you is, and no matter how urgently we deliver it… we can’t do anything to help you unless you’re willing to think and study the materials. You have to open your mind. And you have to read carefully.
What are we talking about? What is the big underlying force that moves the market forward or causes it to collapse? The answer won’t surprise you.
A very old school of economic thought—known as the Austrian School of Economics—teaches these concepts.
(It’s known as the Austrian School because in the 1800s, when these ideas were first discussed, Prussian universities dominated academic economics. The leaders of those schools were dismissive of these new ideas and labeled them “Austrian” as a pejorative term, as if they were unsophisticated and unworthy ideas. Later, the term stuck because many of the best writers and thinkers in the Austrian School studied at the University of Vienna.)
You might have heard of some of these economists: Ludwig von Mises, Friedrich Hayek, Carl Menger, Eugen Böhm von Bawerk, Joseph Schumpeter, and Oskar Morgenstern.
Many of their ideas and theories have since proven to be extremely powerful. For example, it was the Austrian School (Oskar Morgenstern and John von Neumann) that led to the discovery of game theory, an understanding of human decision-making that guided policy during the Cold War. Friedrich Hayek was awarded the Nobel Prize in Economics for his ideas about how money serves as the primary means of communication in an economy, not merely as a medium of exchange and saving.
You don’t need to become an Austrian economist to understand two of the most important foundations of their theories…
One: The economy can’t be understood (or predicted) by the study of groups. It is individuals, making individual decisions to maximize their own utility, that will guide the collective… not the other way around.
Now, I know that sounds pretty obvious… but it isn’t obvious to government economists, Marxists, or Socialists. Many people around the world continue to believe in policies that try to control or exploit groups without considering the obvious negative implications for the individual and their resulting actions.
A classic recent example: when states like Maryland try to increase the rate of income taxes on the rich, only to discover that the amount they collect decreases because individuals simply move rather than let themselves be targeted and treated unfairly.
Two: Inflation can’t be accurately measured by price indexes. It can only be measured at its root—by the increase of money and credit in excess of savings.
Austrian economists would immediately understand that it doesn’t matter whether newly created money flowed into commodities (and created CPI-measured inflation) or real estate (and created an asset bubble). All inflations were caused by the creation of money and credit in excess of savings. Furthermore, that inflation was the cause of the business cycle. To continue a boom, more and more inflation would have to be created. The only way to truly clear the market would be to let prices find their natural foundation, at a level equal to real savings.
This is simple common sense dressed up with math and theory…
An individual doesn’t enrich himself by borrowing capital. He can only enrich himself by carefully increasing his utility (his skills), saving his excess production, and investing that capital wisely, to further increase his production. Nothing could be true of a national economy that isn’t also true for the individual.
But consider our policies over the past decade… or four decades. Has the United States of America worked diligently to increase its national production? Have we carefully saved our excess capacity and invested wisely in further increases to production?
No.
Instead, we’ve been borrowing more and more money, and consuming more and more of our capital. Every downturn in our economy has been met with more printing and borrowing… until finally the numbers are downright insane.
While this is true at virtually every level of our society, it’s easiest to track the numbers at the federal level. President Obama has increased the national debt by $14 trillion in only eight years. That’s more money than our country has ever borrowed—in total—prior to his presidency. In addition, the total size of the balance sheet of our most important bank, the Federal Reserve, has gone from $800 billion to more than $4 trillion.
This, the Austrians would teach us, is a recipe for a massive inflationary boom. And we’ve seen it. The trouble is, the Austrians also teach us that either the inflation must recede to the economy’s natural level of savings, or even greater amounts of inflation will be required to sustain the boom. In other words, the boom will eventually peter out, as demand cannot be sustained enough to keep it going.
Therefore, it was always only a matter of time before increases to production began to wane. It was only a matter of time before profits began to recede. It was only a matter of time before loans began to sour. And it is only a matter of time before a new panic emerges… as every individual tries to salvage whatever remains of the unsustainable boom.
OK, enough theory…
Let me show you a case study of exactly how this Austrian theory plays out in a real industry. And just so you know that I’m not simply looking in the rearview mirror, keep in mind that we originally published this information in October, more than a month ago. We gave our first warnings about the likely collapse of this sector back in 2014. And we made our first trade on this idea—shorting Santander Consumer USA (SC)—about a year ago, making more than 50% in the short recommendation.
The U.S. auto industry has been a primary beneficiary of the current inflation. As you’ll remember, the government injected more than $80 billion in the bailout of one of the automakers alone—General Motors (GM). It also made guarantees to major banks and finance companies that allowed lending in the sector to grow massively. But the greatest insanity was the “Cash for Clunkers” experiment, which saw the government paying people for worthless automobiles.
The result was predictable. We’ve seen an unprecedented boom in auto sales. And as the cycle aged, they had to find more and more buyers. That meant loaning to folks who can’t actually afford a car. Subprime lending soared in 2013 and 2014. Those loans have started to go bad at a shocking rate. (At least, it’s shocking to most people. It seemed inevitable to us, as we warned in 2014.)
You might recall our recommendation last year to short Santander—the leading subprime-auto-finance company. Then, last month, we explained why the next domino to fall in the industry would be the car-rental companies.
Most investors don’t realize that the entire car-rental business is basically a giant leveraged bet on the value of used cars. As we explained last month…
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Since 2010, Avis and Hertz have spent more than $110 billion on new-car purchases. Meanwhile, their used-car sales generated $85 billion. That’s a net cash shortfall of $25 billion… |
Where did all of that capital come from? Debt, of course. And as the Austrian economists will tell you, the big problem with debt-led expansions is that nobody ever wants to pay the money back…
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Of the $30 billion in debt these companies owe, more than 40% of it—$12.6 billion—is due before the end of 2018. That’s a mountain of debt for these companies. But it gets even worse when you study their company filings. Avis and Hertz have committed to purchase another $13 billion next year from the major auto manufacturers. So that’s an additional $13 billion that has to be raised next year and paid for by approximately 2020. |
As long as the amount of money and credit being pumped into the auto industry is growing, car-rental companies can grow their fleets and keep buying new cars. But the moment the credit spigot gets turned off, they have a big problem. In the first place, when lenders start repossessing cars, used-car prices collapse.
And man oh man, have car loans started to go bad. Last month, credit-ratings agency Fitch shocked the market by reporting that car loans packaged into securities were going bad at a record rate. Losses on securitized car loans soared 27% over the last year.
Fitch now expects capital losses on securitized car loans to exceed 10% of loan values by the end of this year. That will exceed the losses seen during the crisis of 2009. And this is just the beginning. Keep in mind, we predicted this would happen in 2014. We first traded on it in 2015. And as I mentioned earlier, we’ve traded on it successfully again this year, shorting Hertz and Avis.
Rental-car companies are exposed to this credit problem in three ways…
First, you have to understand that the car-rental business operates on razor-thin margins. Increases in competition (Uber, Zipcar, etc.) have increased these pressures. As a result, if leisure travel falls due to a downturn in the economy, these firms will see their earnings and cash flows disappear. Here’s what we wrote in last month’s Investment Advisory…
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Over the last five years, despite strong rental-car prices, Avis produced pre-tax profits of only $1.2 billion on revenues of $38 billion. That’s a razor-thin 3% profit margin. Hertz was no better with $1.7 billion in pretax profits off almost $50 billion in sales over the same period (same 3% profits margin). Keep in mind, those margins were earned during a huge boom period for the auto and rental-car industries. The rental-car fleet size hit a 10-year high last year at more than 2.1 million cars – up 33% from 2009. And it hit 10-year revenue highs at $27 billion – up 35% from its 2009 lows. If revenues were only 4% smaller, those profits would completely disappear. Considering they generate around two-thirds of their revenues from nonbusiness leisure travelers, these companies are highly susceptible to any economic downturn. During the last economic downturn in 2009, their revenues fell 16%. And their profits disappeared. |
Second, as a result of these razor-thin margins, car-rental companies are completely dependent on the car-loan-securitization market for capital. Without access to that market, these companies will go bankrupt within 18 months. With losses greater than 10% across the entire auto securitization market, it will shut down. No further auto loans will be securitized, period. That means these companies are on “death watch”…
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Rental-car companies are in constant need of debt to fuel their business. They simply can’t function without it… In 2009, the two companies owed $17 billion in long-term debt. Today, their debt totals more than $30 billion. Their debt-to-asset ratios are more than 70%. Back in 2009, those ratios were only 65%. In other words, the debt is huge and growing. Avis and Hertz raised around 70% of this debt by selling securitized car loans [ABS] to investors. These ABS have maturities ranging from three to five years, so the companies have to roll them over regularly. That means they need constant access to the credit markets to continue operating. |
Third, and most important, these companies are at the mercy of used-car prices. The only significant asset on their balance sheets are used cars. Together, Hertz and Avis own $26 billion worth of used cars (62% of their assets). If used-car prices fall, say just 15% on average, these companies will lose around $4 billion – or more than their total equity.
But losses don’t have to get that big for the company to collapse. Just the fear of a decline in used-car prices would wipe out the company, because that would lead to much higher borrowing costs. From the issue…
When subprime borrowers start defaulting, the used-car market will be flooded with inventory. Used-car prices will collapse. Avis’ and Hertz’ $26 billion used-car inventory will be worth far less, which will make them even more dependent on the debt markets to feed an even larger appetite for cash.
The companies are also highly exposed to interest-rate changes. Because of their thin margins, any rise in interest rates they must pay would cause profits to collapse. A 1% increase in interest rates would wipe out close to half of their profits, sending shares plunging…
Even many loyal subscribers, I’m sure, thought our dire warning about these companies in October’s issue were over the top. And our warnings surely would have given plenty of fodder to our critics who accuse us of trying “scare” investors.
We didn’t get “lucky”…
Bu we didn’t find a needle in the haystack. We followed a well-known principle of economics. We followed the debt and inflation cycle in the auto industry. We simply connected the obvious dots and we profitably shorted the weakest and most vulnerable business.
Over the next week, I’m going to teach you more about this ongoing cycle. I’m going to introduce you to more of the tools we use to find these kinds of situations. And I’m going to show you how to make… not just 50% or so by shorting… but 20 and 30 times your money by buying put options on situations like these.
Your friends will think you’re crazy. But you’ll know better.
Again, I’m doing all of this for free. You won’t have to pay me a cent. I know that’s an unusual promise for any business (or businessman) to make. I won’t blame you for being skeptical. Or even cynical. After all, we are a for-profit business.
Why am I doing this?
Well, there is a commercial reason. I know that unless you can really understand what we’re doing and why it works, you won’t subscribe to our work for long.
My goal isn’t to sell you a newsletter for $99 for a year. My goal is to make you a great investor who is able to profitably use all of our newsletters for the rest of your life.
To achieve that goal, you have to become a sophisticated investor. That’s why I spend so much time trying to educate you about economics and finance.
There’s a world you might not see… yet. But if I just take the time to show it to you and prove that it works, well, I have a customer for life. And there’s something more to this… something I can’t prove but I completely believe: I’ve always known that if I simply did my best to give you the information I’d want if our roles were reversed, then everything else about my business would work out fine.
And so far, that has always been true.
I sincerely hope you’ve learned something today. And I hope you’re looking forward to learning a lot more about how the credit cycle works and how it influences the stock market.
Reeves’ Note: We’re seeing unprecedented warning signs in credit markets all around the world…
The global scale of these problems means the coming crisis—what Porter has called “the greatest legal transfer of wealth in history”—will be truly historic.
Folks who don’t see what’s coming could be wiped out… while those who prepare now could set themselves up to earn a fortune, as much as 10 to 20 times their money, as the inevitable bust plays out.
This is why Porter is hosting a live presentation on Wednesday, November 16 at 8 p.m. Eastern time to explain it all… what he’s calling his biggest trade yet.
He’ll tell you exactly what happens next and what you need to do to prepare. If you still haven’t reserved your spot yet, we urge you to do so now by clicking here.