From Porter Stansberry in The S&A Digest:
A brief Digest today. But I think you'll agree... it's very important.
The signs of a top in the bond market have become impossible to ignore again... much like they were last May. And stocks look dangerous, too.
Before we begin, though, a word about my dear colleagues, David Eifrig and Steve Sjuggerud. Last year, they disagreed with me that a correction in bonds (which I predicted) would spark a decline in the stock market.
Instead, they both argued that I was wrong to worry... that stocks were going to continue to run much higher. While bonds did correct like I predicted... obviously, they were right about the stock market. Stocks continued to move higher.
But in my view, they were right for the wrong reasons. The stocks that are driving the market higher (like electric-car maker Tesla, for example) are low-quality. The quality of bond issuance (as you'll see below) is even worse. Thus, I continue to disagree that stocks are safe and should be bought aggressively now.
You may find our difference of opinion startling, especially if you're new to our work. Stansberry Research, as a publishing company, has no uniform opinion on stocks or bonds. Instead, we offer independent research and opinions from various analysts. The only way we could possibly always agree is if some of us were lying.
We think our approach of offering different views gives our subscribers a more complete picture than the typical one-sided approach of many other firms. Besides, I couldn't recruit or retain talented analysts if I told them what to write or how to think. Talented folks won't tolerate being told how to do their jobs.
As for who is going to be right and whose advice you should follow... that's easy – mine.
I reiterated my warnings last week that the stock market was getting "overheated" and likely to enter a correction (a decline of 20% or more) at some point between now and June. A few more critical data points recently reached my desk, and I want you to be aware of these classic "signs of the top."
First and most important, the investment mania for fixed-income investments, which I thought peaked last May, has returned. As you can see in the chart below of the Barclays High-Yield Bond Fund (JNK)... bond prices have almost returned to last year's highs, sending yields down into what I consider to be dangerous territory for new buyers.
Investors spent $3.4 billion in the first quarter of 2014 buying high-yield bonds, outpacing (by a wide margin) the $1.8 billion they invested in high-yield debt in the first quarter of last year.
And in some important ways, the mania is now even more dangerous...
The quality of this credit has seriously declined with a huge increase in the issuance of "payment in kind" (PIK) bonds. PIK bonds give borrowers the right to repay debt by issuing more debt. These loans are designed with the knowledge that the borrower will at some point have trouble making minimum payments.
So far this year, $1.9 billion of PIK bonds have been issued, far more than in the first quarter of last year ($1.2 billion). During all of 2013, $12 billion in these bonds was issued, the most since 2008. It seems likely to me that if this mania for risky debt continues, the issuance of PIK bonds will surpass the level of 2007. In short, we are entering a new period of even greater financial excess.
The trouble isn't only in bonds. The amount of initial public offerings (IPOs) is soaring, while the quality of the firms going public is declining. Earlier today, four start-up firms went public – online food-delivery service GrubHub, energy-software vendor OPower, call-center software maker Five9, and medical-technology company Corium. These offerings raised more than $400 million by selling stock to the public. Only one of these firms is profitable (barely). The combined net income of these companies is negative $52 million.
Finally... investment inflows into mutual funds have all grown substantially. Weekly money flows into stock-focused mutual funds continued strongly – $8.4 billion. Bond mutual funds set a new recent high-water mark. A total $6.9 billion flowed into bond mutual funds this week, a new eight-week high. Even emerging markets have joined the party. Emerging-market mutual funds saw $2.5 billion of inflows this week – the first inflows in 23 weeks.
Inflows mean higher stock prices – which is great for folks who have already bought stocks. But as these inflows push prices ever higher... the number of reasonably priced opportunities is bound to diminish. If you can learn to be a buyer of high-quality stocks when everyone else wants to sell them, you'll do a lot better with your investment results than if you are only capable of moving with the crowd.
Given the size and the duration of these inflows, we don't believe today is a particularly attractive moment to be buying stocks, in general. Given what's happening in the debt markets, we believe it could be a terrible time to be buying bonds. What should you do with this advice?
Just be sure to follow your trailing-stop losses. Think about taking some profits in your more speculative investments. Realize that a bear market in stocks could also trigger the Federal Reserve to become more aggressive with its printing strategy, resulting in higher prices for energy and precious metals... and much lower prices for bonds.
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