In This Episode

What happens when 15% of the largest companies in America can no longer afford the interest on their debts? As the Federal Reserve pushes interest rates past 3%, Porter makes the case that we could see investors pulling out of the stocks to put money back into the safety of government bonds. Is this how the air comes out of the current bull market in equities?

Extreme Value analyst and editor Dan Ferris joins the show to talk about how to spot the next “$6 Amazon Moment”, how his value investing style has changed in an overheated market, and what could usher in the next “Golden Age of Value Investing.” Porter asks Dan to explain the first thing he looks at when evaluating a beaten down stock and reveals a scenario for $5,000 gold that doesn’t sound outlandish, at all.

A listener writes in to tell Porter he’s completely backwards when it comes to position sizing with bonds, and Buck tells everyone he’s moving to “the swamp” in DC.


Featured Guests

Dan Ferris
Dan Ferris
Editor, Extreme Value
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Transcript

What happens when 15% of the largest companies in America can no longer afford the interest on their debts? As the Federal Reserve pushes interest rates past 3%, Porter makes the case that we could see investors pulling out of the stocks to put money back into the safety of government bonds. Is this how the air comes out of the current bull market in equities?

Extreme Value analyst and editor Dan Ferris joins the show to talk about how to spot the next "$6 Amazon Moment," how his value investing style has changed in an overheated market, and what could usher in the next "Golden Age of Value Investing." Porter asks Dan to explain the first thing he looks at when evaluating a beaten down stock and reveals a scenario for $5,000 gold that doesn't sound outlandish at all.

A listener writes in to tell Porter he's completely backwards when it comes to position sizing with bonds, and Buck tells everyone he's moving to "the swamp" in D.C.


Buck Sexton: Broadcasting from Baltimore, Maryland, and New York City, you're listening to the Stansberry Investor Hour. Tune in each Thursday on iTunes for the latest episode of the Stansberry Investor Hour. Sign up for the free show archive at investorhour.com. Here are the hosts of your show, Buck Sexton and Porter Stansberry.

Buck Sexton: Hello, everybody. Welcome to the Stansberry Investor Hour. Another fantastic episode planned for this week. I am nationally syndicated radio host and sometime TV egg chef, Buck Sexton. With me here today, Stansberry Research's main man, the one and only, Porter Stansberry. Mr. Porter, good to see you sir.

Porter Stansberry: Hi, everybody. Glad to be here. For those of you who don't know, we normally record the podcast with Buck in New York City and with me here stuck in Baltimore, but Buck is actually here today. I don't know if there's anything Buck was ready to announce publicly, but he may be spending more time in this neighborhood.

Buck Sexton: I'm going to be a swamp dweller officially. Well, I guess I already kind of am, but moving down to D.C. to work on a project. We will give an announcement, I think, on the next podcast about the specifics, but good things coming. Good things coming.

Porter Stansberry: So I've got a couple of announcements that I am ready to make. First of all, it was a grueling series of contests, but we now know who is the best shot at Stansberry Research. We had a tryout to be in a shooting contest out at my hunting club. These are shotguns, by the way, shotguns and clays. No animals were harmed in the filming of this contest.

Buck Sexton: There we go.

Porter Stansberry: And we're now certain that Porter Stansberry is not only the founder of Stansberry Research, he's also the best shot in the clays and trap course. So I shot, I think, 66 birds yesterday, and I think the nearest guy was like 10 behind me, so I was the top shot at Stansberry Research. Happy to announce that.

Another thing I want to announce, Stansberry Research has made a decision to begin to sponsor professional golf. Now there's a lot of golf played in these halls, a lot of people here play golf. Also, golf is sort of the sport of stockbrokers, so makes sense for us to pick a golfer. And I'm pleased to announce for the first time anywhere, Kevin Kisner is the first golfer Stansberry Research will sponsor. Not the last, but the first. We're looking to add two or three more golfers to our ranks, and potentially in the future sponsor a tournament. So if you guys are golf fans, not just podcast listeners, please root on Kevin Kisner. Look for our logo on his shirt in the upcoming tournament. Now, Buck, what could we call Kevin Kisner's golf fans who are also subscribers of Stansberry Research? Could they be Kisner's Crazies?

Buck Sexton: I don't know. Kisnarian sounds like a German philosopher from the 18th century.

Porter Stansberry: The Kisnarians. I like that. That's good.

Buck Sexton: That could work. That could work.

Porter Stansberry: All right. So those are some announcements. I shoot a shotgun, and Kevin Kisner is now sponsored by Stansberry Research. Do we have any other announcements, Buck?

Buck Sexton: Nothing for right now. Not that I'm aware of. Although you are also the inventor of the world's finest razor, which I left out of your intro.

Porter Stansberry: Oh, I think that's how I should be known. The One Blade. If you guys haven't tried it yet you should. It's the best. All right, well let's get to something the readers can use besides all this boasting about my professional golf associations and my shooting ability.

Buck Sexton: Can I tee us up for our guest this week? We've got Dan Ferris who's going to be joining us in just a little bit. He is the lead analyst and editor of the Extreme Value investment research service. You might remember Dan from a few months back on Episode 35 when he was on the show talking with us about the safest way to invest your money. I'm an Extreme Value reader by the way, and have taken action based upon Extreme Value, so I'm excited to see Mr. Ferris here.

Dan is back in Baltimore, and he's here to talk with us about how he sees a potential age of value investing. And to tell you about his latest videos on YouTube with titles such as "The No. 1 Most Important Skill For Investors," "How To Buy Amazon at $6 Per Share... Over and Over," and "A Classic Value Play With Three Times to Six Times Potential," or "3X and 6X Potential" for those in the know.

Also, we need your help, dear listener. Please go to our iTunes page and hit the subscribe button. Leave a comment or review. When you subscribe to the podcast, each new episode will automatically appear in your podcast app each week. That way you never miss a beat. If you've been loving the show and finding value in our weekly broadcast, please do us the favor of subscribing on iTunes and leaving us a review or comment when you do. All right, with that, Mr. Porter.

Porter Stansberry: Well, Buck, here's the fun thing about finance. I know finance isn't necessarily your beat. You're learning, and politics is your beat. We're going to get to politics. But one thing about finance you have to understand is that if you borrow money, you will be expected to pay it back with interest. This is news to some people, particularly I think in the political side of things. They may not realize that they actually have to pay the money back. I don't think that's ever really occurred to them.

Buck Sexton: No, you can just tax other people to pay it back for you.

Porter Stansberry: But even then, you still have to tax them enough to pay it back, which they are not very good at either.

Buck Sexton: That's true.

Porter Stansberry: The other thing I think is funny is I think Washington is the swamp that invented the idea of a predatory loan. I've always thought that that title was one of the most hysterical things I've ever heard of, a predatory loan. So let me get this straight, I'm going to let you borrow money, you get the money, you walk away with it and I've done something that was predatory? How is that possible? Anyways, they say it is.

One thing I noticed recently, and I wrote about this in the Digest last week, is that there are a number of U.S. corporations that do not appear to be able to pay back their debts. I think that might cause some problems. Especially as interest rates rise that service becomes more expensive, and maybe people stop loaning to corporations instead of choosing to loan to the government where they know the money is safe. Just an idea.

So you might think, "Well, sure Porter, some companies out there can't pay their debts. They will go bankrupt. What's the big deal? That happens all the time." Buck, what if 15% of the 1,500 largest companies in America, so is that – let's call it 175 companies out of the largest 1,000 or so stocks. What if 15% of them can't pay the interest on their debt?

Buck Sexton: Seem to be a problem.

Porter Stansberry: That would seem to be a problem. Now, as an example, we could look at General Electric. So General Electric is one of the largest companies in the world. Every year GE is now spending almost $3 billion a year on interest. And here's the problem, they only make about $700 million more than that. So they're spending virtually everything they make on interest, and they have to spend another $7 billion on something called CAPEX, which is investments in capital equipment and maintenance. So they're not making enough to cover their CAPEX and their interest, which means they have to add to their debt total every year or they're going to have a big problem.

So what happens as investors start withdrawing capital from risky debtors and instead buying the 10-year Treasury, which is now yielding 3%? What happens if the 10-year Treasury goes to 4%, Buck? If you can make 4% a year risk-free, why would you lend to companies like Sprint for example? Sprint is now paying $2.5 billion a year in interest. In interest alone. And here's the problem. They don't make nearly that much. In fact, they're $2.3 billion short each year. That's a pretty big gap.

Anyways, I published a whole list of companies that can't afford their interest in the Digest, and I was shocked to find out that, as again, as I said, it's 15% of the largest 1,500 companies in America.

Buck Sexton: America is going to be one of those companies at some point.

Porter Stansberry: America as a whole is certainly in big trouble. But you're talking about a stock market that's at a record high. You're talking about, until very recently, stock market volatility in fear being at a record low. I don't think people have yet figured out that higher interest rates are going to result directly into a big increase in corporate insolvency, and I'm pretty sure that when you go bankrupt your stock price goes to zero. So I'm having a hard time figuring out how the stock market as a whole is going to do well if something like 15%t of the largest 1,500 companies are heading to bankruptcy.

Buck Sexton: That could give you like a 20 or 30% decline in the stock market pretty quickly.

Porter Stansberry: Alone, and that's not even talking about the resulting negative sentiment and everything else that goes along with it. So folks, if you have money in the stock market, what I told everybody is it's time to wake up and smell reality. Higher interest rates are going to result in much lower stock prices starting now. So forewarned is forearmed. Go out into the future, my children. Do your best.

Buck Sexton: So how do people react to that in terms of their investments right now?

Porter Stansberry: Well, the advice I gave was that you should scale down. So let's say your normal 35 -year-old could be 100% invested in equities because he doesn't have to retire in the next 30 years, and he wants to continue to accumulate equity, great. I would recommend that guy scale down to about 60%. So in other words, have 40% at least of your portfolio in things that are very, very safe.

Now look, there's all kinds of things that are very, very safe. Local real estate can be very, very safe. Gold can be very, very safe. Government bonds can be very, very safe. Just something that you know has a firm foundation of value, not somebody you're counting on going up forever like Netflix. So you'd want to take some profits, and most importantly you want to follow your trailing stop losses at a time like this.

We've had a nine-year bull market in stocks. They're trading at record valuations all across different sectors of the stock market, and you've got really bad underlying financial fundamentals. Those two things are going to cause a problem for a lot of investors, but you don't have to be one of them. You can scale back. You can raise some cash. You can be more conservative than you otherwise would be.

And I go back to my number one prediction for this year was that gold will outperform bitcoin. I don't know where we are in bitcoin, but I think it's down quite a bit. It's rebounding. My solar investor tells me it's rebounding. Well, good. I hope it does well. I don't expect it to. You want to look around. There's a lot of very weak, financially, companies out there. They're going to go bankrupt soon, and there's going to be a big credit default cycle led by higher interest rates.

So if we get more economic growth, if we get more inflation, and it looks like we're getting both, that 3% rate on the 10-year Treasury going to 4%, that's a sea change in the markets. We have not seen interest rates at that level in a decade. And as it becomes possible for people to make adequate returns without taking any risk, they're going to make that choice. People are going to take money out of stocks and put money into bonds, government bonds, bonds that are extremely, extremely safe. That'll result in lower stock prices, but it will also result in less capital available for risky corporations to borrow, and that's what's going to start a lot.

Buck Sexton: So this is when people don't have chairs, when the music stops.

Porter Stansberry: This is the music – it's not stopped yet.

Buck Sexton: But I'm saying, it would be stopped when they can't borrow anymore to service the debts they have.

Porter Stansberry: This is at the end of prom when they turn on the lights.

Buck Sexton: Oh, that's rough, yeah.

Porter Stansberry: The music is still going, but the lights are on, and you don't have to go home, but you can't stay here. That's where we're at. I don't know exactly what's going to start the tsunami, what will start the panic. I don't know. I mean, corporate earnings are still very, very good. There's still reasons to invest in lots of good businesses. But the air is coming out of the market, and the weaker players don't have anywhere to sit.

There are a lot of companies like GE. I mean just remember what happened last year. GE went from 30 to 12 when investors suddenly woke up to the fact that, "Holy _____. GE has got a whole ton of debt, and they can't afford it, and they have no cash flows after you subtract capital investments." Yeah, that's a really lousy business. Hey, Buck, would you like to own a business that consumes more cash every year than it produces?

Buck Sexton: No, right.

Porter Stansberry: But for some reason for the last decade people have ignored that fact about GE and have bid the stock price up. Sooner or later, though, that financial reality hits you like a bucket of cold water in the face, and that's going to happen to more and more investors this year. It won't just be GE. It'll be more and more companies.

I think Sprint is already down. It went from like $8 to $5 or so, and that company should go to zero. Now they're trying to merge with T-Mobile. Maybe they'll be able to, maybe they won't, but what a terrible bet that is. I mean that company is $30 billion in debt. I don't know why they want to merge with it, but it doesn't make any money, and that's a problem. And as interest rates go up, companies in that position, that are consumers of capital, they're going to see their stock prices get hit. And if you want to see a list, well subscribe to the newsletter, read the Digest from last Friday. I printed 10 of the largest negative earning companies. Companies that cannot afford their interest on page 10 of the Digest.

Buck Sexton: What would be your expectation, Porter, for some of the companies that we talk about here that you describe as highly capital efficient, things like Facebook, if and when the lights go on, the music stops here?

Porter Stansberry: So there's some pretty major on that list, Buck. Stuff you've heard of.

Buck Sexton: Right, No, of course. These are the companies you're saying are – but I'm saying for the companies that are doing really well, when these guys all go down, is there just a temporary – does it turn into a blip on the radar? If you're invested in Facebook, Amazon, these companies that are just printing machines for money right now, do they weather this storm pretty well anyway though?

Porter Stansberry: I think that they will weather the storm just fine. I think there's just going to be a lot of volatility, and I think people that do things like pay whatever Amazon's multiple is today, 80, 800, I don't even know, 100 times earnings. I don't even know where it's trading at. I mean huge multiples. The air pockets are going to hit those stocks.

So when there is a correction, and there will be a correction this year, there's no question, no doubt in my mind that the stock market as a whole will fall at some point by at least 20% this year. That's a bear market. Correction is 10%. We might already be at a correction level now. I'm not quite sure exactly. We're close to it. We'll hit a 20% decline, and those stocks will all suffer. They will all decline between 15 and 35%. But the stocks I'm talking about, Buck, they'll go to zero.

Buck Sexton: Right. Those ones are toast.

Porter Stansberry: They're really, really bad news. So you can look at this one of two ways. You can say to yourself, "Well hey, I'm a long-term investor. If Porter is right, great. I can raise some cash and I can be ready to buy stocks when they get cheap," which is exactly what I recommend you do. But what you don't want to do is go is go, "Hey, you know what? I've got to make a huge investment later this year in December, and so I'm going to put all my money into stocks right now." I think you'd be sorry if you did that.

And most importantly, there are a lot of investors who are in stocks, and they're in ETFs, and they're in mutual funds, and they don't understand that what they own is not solid. If I told investors two years ago that General Electric is at risk of going bankrupt, they would have never listened to me, and that's the truth. They're going to have to break up that company, and there's no question that parts of it will fail. Some of it will survive.

They have good businesses in GE, but they're just wrapped in a big pile of debt, and I don't know how they're going to solve that, but they'll figure something out. Parts of it will survive. But parts of it are going to zero. There's a lot of stuff still in GE Capital there's definitely going to zero. They can't sell it. It's probably worth less than zero, meaning that the losses in GE Capital are going to do more than consume the capital that GE has in that little pocket, and it'll consume other capital too.

But that same thing is going on with a lot of those stocks on that list. Those stocks will actually go below zero. By that I mean that it won't just be the equity holders that get wiped out – the bond holders will suffer losses in all those stocks as well, and that day of reckoning is here.

Buck Sexton: So this is the cross the stream scenario from Ghostbusters.

Porter Stansberry: That's right.

Buck Sexton: Like it's all coming down.

Porter Stansberry: I've been telling people since 2015 that this moment would arrive. And what the catalyst is is rising interest rates. I, for a long time, thought the catalyst would be rising default rates because I didn't think the Fed would ever raise interest rates. I didn't think the moment would ever come, and it is, and they've done it, and now you're going to see the fireworks.

Buck Sexton: How quickly could we see you think the Treasury go to 4%?

Porter Stansberry: Yeah, not quickly, Buck. Those things don't move overnight, but we've gone from 2% to 3% in six months, so another six months, another 12 months.

Buck Sexton: On the grand scheme of things that's actually pretty fast.

Porter Stansberry: Yeah, but you also have to remember, the stock market is looking ahead to that. So I mean these companies are going to have financial problems because of the expectation is that rates are going to go up. The expectation can be just as deadly as the fact. I mean, the bond holders are not going to wait until Treasury rates go at a four to start selling the hell out of these things.

Buck Sexton: Yeah, they want to get their money now before it's too late.

Porter Stansberry: Yeah. When there's going to be a panic you want to beat the rush. So we'll see what happens, but the market has been reacting very poorly to a lot of good earnings, and I think that's a sign of what we're seeing here, that this – Buck, we have just been living in a financial fantasy land for almost a decade where the Fed made money so cheap that any company could borrow almost any amount of money, and that fantasy land is ending. It is over. And the cold harsh light of reality of having to pay your bills is hitting.

Buck Sexton: Do you think gold price could be a canary in the coal mine for this?

Porter Stansberry: I expect gold to do very well in this scenario.

Buck Sexton: So it's a yes.

Porter Stansberry: Very well, yeah. I think that you'll see – by the time that this has run its course, and this could be a two- or three-year credit cycle, by the time this has run its course gold will be over $5,000 an ounce.

Buck Sexton: Wow.

Porter Stansberry: Yeah.

Buck Sexton: What is its all time high up to this point, $1,900?

Porter Stansberry: Yup, mm-hmm.

Buck Sexton: It was down at what, $300 or $400 in the '90s, so it's had a tremendous rise up to this point, but – it's not $1,900. What was it, $1,300 now?

Porter Stansberry: I personally started buying gold in the early 2000s, 2002, 2003, 2004, and when I started buying it it was around $400 an ounce. So yeah, it's gone up quite a bit.

Buck Sexton: But you think it's going to – I mean, $5,000 an ounce is – that's a lot.

Porter Stansberry: It's not that much if you look and if you consider how much money and credit has been created in the last decade. I mean, the Fed did print $4 trillion of new bills, and the federal debt did go from $8 trillion to $20-plus trillion.

Buck Sexton: Zero fear in your mind, or let's say 1% fear in your mind that if somebody got into gold right now, in five years they would feel like, "Oh gosh, what have I done."

Porter Stansberry: No, zero chance of that.

Buck Sexton: Dan Ferris is with us. He's the lead analyst and editor of Extreme Value, and one of the original Stansberry Research analysts joining Porter in 2000. Dan's research focuses on some of the safest and most profitable stocks in the market, great businesses trading at steep discounts. His strategy of finding safe, cheap, and profitable stocks has earned him a loyal following, as well as one of the most impressive track records in the industry.

In fact, Dan holds three of the top 10 all-time highest returning closed positions in the Stansberry Hall of Fame. Dan is an avid guitar player and lives in the beautiful state of Washington. His work has been featured in Barron's, and he's appeared on Fox Business News, the Street, and Business News Network. Please welcome to the Stansberry Investor Hour, Mr. Dan Ferris.

Porter Stansberry: Dan, do you know what Amazon, the multiple is right now?

Dan Ferris: I think it's – well, the multiple that I keep track of is lifetime earnings. So the multiple of all the profit they've ever earned since –

Porter Stansberry: They've only made about $3 billion in profit, total.

Dan Ferris: Right, so the multiple at this point is something – the last time I looked at it – I actually haven't updated the spreadsheet in maybe a couple of weeks here, so who knows. It could be double. But the last time I looked at it I think it was 34 times all the profit they've ever owned since they became a company.

Porter Stansberry: It's got to be more than that. I might have the $3 billion number wrong.

Dan Ferris: Yeah, I think I'm going – I think I'm pretext profit, total. And I'm not –

Porter Stansberry: OK, here I've got some data for you.

Dan Ferris: OK.

Porter Stansberry: Amazon is now a $750 billion business. And by the way, my criticism of Amazon is a stock. Has nothing to do with Amazon as a business. It is a world-class business, and Bezos is the greatest business person since Rockefeller, hands down. I'm not ever betting against Amazon.

The other thing you all should all know is that I bought Amazon stock with every penny I had saved in the world, which was about $10,000, $12,000 in 1997. If I had just done nothing else I would be wealthier than I am right now with never having had a job, never started a business, never employing 500 people. All I had to do was be smart enough to invest in Jeff Bezos, which I was. What I wasn't smart enough to do was to not sell that stock two years later and pay for an epic spring break vacation with my fiancée at the time.

Dan Ferris: It was epic, though.

Porter Stansberry: It was. It wasn't quite worth all of that. I think I my split-adjusted entry price if you look back on it now, Amazon's trading at $1,500 a share. My split adjusted entry price was around $3.

Dan Ferris: Nice.

Porter Stansberry: Yeah. So that's a lot.

Dan Ferris: Would have been nice.

Porter Stansberry: That's a lot of money. I _____ up. All right, but multiple, so $750 billion market cap business now trading at 250 times earnings. Let me just pause at that. It's going to be very difficult for investors buying at this price to do well going forward because Amazon is already one of the largest companies in the world. How does Amazon get 250 times bigger from here?

Dan Ferris: Yeah, how do you get your money back while you wait 250 years? You live to be 400.

Porter Stansberry: Yeah. Good luck with that. I mean I think Amazon is going to continue to grow. I just don't – I don't know how it continues to expand its growth rate, which is what it has done for the past 10 years.

Dan Ferris: Right. You constructed this thing, this wonderful marvelous thing where he started with books, and everybody said, "Oh, who cares," and then he added, and he added, and he added. And then the pizza teams, he has this thing about the teams – the two pizza teams, right? So he got all these teams that were just small enough that they could be fed with two pizzas. And the two pizza teams just proliferated like a virus, and created a gazillion new things to do, including AWS of course.

So now it's this massive thing. And you have to wonder at some point – and it's a common wonder. I realize the entire world asked this question in the financial press a million times, right? What happens with the retail business over time? Does it ever become a profitable thing? Because the model is for them – Bezos says, "We just focus on the customer, so we don't focus on the competitors." Well, that's not quite true because what you do is you look at all the competitors and you say, "Oh, the margin is here. Well we're going to suck it out down to here, and that's what we're going to do." So it's defined by competitors in that way.

Porter Stansberry: Yeah, I don't think Amazon really has to make a margin on the retail business. They have figured out a way to use the list for other things. But I think the bigger question for investors is how many times has Amazon stock fallen by more than 50% in its 25-year history? And the answer is probably, I don't know off the top of my head, but I guarantee it's at least a half a dozen times.

Dan Ferris: Sure.

Porter Stansberry: I feel very strongly that we're approaching at one of those periods where people are going to have to sell Amazon stock not because necessarily they believe that Amazon is going to do poorly, but because they're going to have to sell stock period, and that's going to be a stock they can sell.

Dan Ferris: Yes.

Porter Stansberry: So we'll see if there's a good entry point coming. But, Dan, you were teasing us by saying you could buy Amazon at $6.

Dan Ferris: Okay, so you can't buy Amazon for $6. Obviously when it's –

Porter Stansberry: Oh, hold on. You just said we could.

Dan Ferris: Right.

Porter Stansberry: Now I don't believe you.

Dan Ferris: Right, now you don't believe me. So the point there was that when Amazon was $6 and a little below $6 in 2001 if I'm not mistaken, to get to that point – of course since that point it's been the most incredible homerun in the world, but to get to that point, and to find it attractive at that point, you had to endure what? Well, to $100 then down to $40, then it was back up to $100 then cut down to $40, then back up to like $80 or $90 and then, bam, down to $6. It was brutal to get to that point. Nobody wanted to be in at that point. I mean getting out and paying for an awesome spring break probably – who knows if you'd have made it through that $6 moment.

Porter Stansberry: Well, I still would have been up 100%. Because I bought in '97 at $3.

Dan Ferris: Doubled your money.

Porter Stansberry: Yeah, I would have been –

Dan Ferris: That's right.

Porter Stansberry: Still beating the market.

Dan Ferris: That's right. So that's what I'm talking about. And we don't think of Amazon as a cyclical business, although as Porter just alluded, there's something cyclical about just about everything, and there will be a minus-50% moment for Amazon. So if you look at these other companies –

Porter Stansberry: So you're using Amazon as a metaphor.

Dan Ferris: A metaphor.

Porter Stansberry: You're saying how do you buy stocks like Amazon at $6.

Dan Ferris: Right.

Porter Stansberry: And the only way you get to buy a stock like Amazon at $6 is if you have found a stock that is already declined by 90%.

Dan Ferris: Or something huge, yeah.

Porter Stansberry: Something huge.

Dan Ferris: Just call it 90%, that's fine.

Porter Stansberry: So you went shopping for these stocks that have been completely brutalized.

Dan Ferris: Completely brutalized.

Porter Stansberry: But the point I'm trying to make is, how in the world can you tell the difference between a company that's gone down 90% because it's not worth anything, and a company that's gone down 90% but is really being led by a guy like Jeff Bezos where there's an enormous reservoir of potential energy and profit in this business? How do you tell the difference?

Dan Ferris: OK, so at this point just because we're talking about highly cyclical industries, right? And I've had some experience with these in the past that hasn't always been good. It may seem really stupid to you, Porter, because I think you've probably done this better than I have, but the main thing you have to do is don't try to find the bottom. Don't worry about being late. Just for God's sake don't be early.

Wait until the industry, and particularly the companies that you're watching, go through this awful moment where the world questions if they will survive, but the management's good, they attract new capital, they recapitalize, they probably buy assets absolutely for pennies on the dollar for well below new building cost, for well below current market value, and then away you go. The company is going to survive and then all of a sudden wham, off it goes.

Porter Stansberry: So this is buying homebuilders in 2011.

Dan Ferris: Right, exactly.

Porter Stansberry: So you know, Americans are not going to stop buying homes. We've got to live someplace. And you know these stocks are bombed out, they're all down 80% or more, and then you go find the one that does what? What is it when you're sifting through a deeply cyclical industry that's been sandpapering along for three or four years not going anywhere? Sure, you wait until there's an uptick in new orders. Sure, you wait until there's some uptick in prices in margins, you see demand coming back. The associated data is good, Realtors come out and say, "We have more spring shoppers than we've had in five years." There's more mortgages have been approved. You can tell the demand is coming back. But out of the dozen or two dozen homebuilders that are out there that are treading water, haven't gone anywhere in five years, how do you know which one to buy, or do you buy the whole sector?

Dan Ferris: Well you know, buying the whole sector, if you're that kind of investor, it's not necessarily a bad thing. But I prefer not to do that because a lot of the times companies can linger on, and on, and on for a long time, and then they'll die long after you thought they would. So you want to find a company that preferably, and this is the main thing for me, the first thing is a great balance sheet. Find the better balance sheets. Find the ones that aren't overloaded with debt. And the stuff that we've found we looked at the market value of assets, and we looked at the amount of debt, and we thought, "Wow, there's a lot of equity here."

Porter Stansberry: Now you want a big equity cushion. Now most people can't look at a balance sheet. They really can't make sense of it. I know that's what you do in Extreme Value, but can you walk us through, or will you give us one tip, will you walk us through one such situation? It doesn't have to be what you're buying right now today, but just give us some details so that we'll know what this looks like.

Dan Ferris: Sure. The only thing I won't disclose outside of the newsletter is the name of a specific pick that people pay us a lot of money for. But we did find a couple ideas in the dry bulk shipping sector. And we looked at – it's exactly as you just represented with the homebuilders. We saw the shipping rates, the day rates that you pay to employ these ships to carry iron ore and coal and all this other stuff all around the world for you.

Porter Stansberry: All right, hang, hang, hang.

Dan Ferris: We saw those rates going up.

Porter Stansberry: Hang on. I've got to interrupt you about this one.

Dan Ferris: Sure.

Porter Stansberry: I saw you doing that, and I think the only reason why you'd ever invest in a shipping company is if you had never owned a boat.

Dan Ferris: That's right.

Porter Stansberry: I've owned boats. No way am I ever going to own a shipping company. So let me get this straight. You pour perfectly good capital into a gigantic machine that consumes fuel, and employees, and rust. And you know for sure that in 20 years it will be worth nothing. And you try to make money on that based on what the rates for shipping might be over the duration of the life of the vessel. The only thing you know for sure is that the rates will not remain the same. And you also know that historically the industry overbuilds every single time. So at some point, at some point over the 20-year cycle your boat will be worth nothing long before its time.

Dan Ferris: Possibly. We have just been – yeah, we've just been through that.

Porter Stansberry: But you're going to beat all those odds.

Dan Ferris: I think we are.

Porter Stansberry: Okay, all right. How is it going so far?

Dan Ferris: Swimmingly.

Porter Stansberry: Good.

Dan Ferris: Absolutely swimmingly.

Porter Stansberry: So you also know that in this business, as bad as I make it out to be, which it is a terrible business, the terrible businesses is always have this once-in-10-years spike, junior minors have it, the dry bulk shippers have it. These terrible businesses you should never own. At some point every 10 years will go from one to fifty. Meaning a stock will go from one to fifty. Who knows why, but it does happen. Lightning strikes in these industries. And so you think we're at the bottom, or we're on the way up now in the dry bulk.

Dan Ferris: Yeah, I think we're at a position where if you look at all those industry, I don't know, metrics you can call them, and then if you look at the specific names that we have, in this moment in time I think we've got it right. I really do.

Porter Stansberry: And I know that when you go through these there are massive qualitative differences in the balance sheets.

Dan Ferris: Oh my lord yes. Put it this way, with the companies that we've found, they could liquidate 40%. Our conservative estimate was like 50 or 60%. We talked to some more people, we looked at what the market was actually getting for ships, and it's really about 40% of their fleets, and pay off all their debts. That's great. Because there is a fairly liquid market for these things now. And their competition, almost every name you find in their competition, they could liquidate 100% of their fleets and still have hundreds of millions, to even in some cases over a billion dollars left in debt to pay.

Porter Stansberry: Right, they're not going to make it.

Dan Ferris: No.

Porter Stansberry: Yeah, not unless something weird happens, which it does in this industry.

Dan Ferris: It does.

Porter Stansberry: So what will happen is the stocks will actually go up, they'll raise new equity, and guess what they will do with the new money? You know what they will do.

Dan Ferris: Yeah, I do.

Porter Stansberry: They'll buy new boats.

Dan Ferris: Yeah. At this moment they'll pay for new building boats.

Porter Stansberry: Yeah, they will.

Dan Ferris: It's insane.

Porter Stansberry: It's like same thing happens with the Texas oil industry. As soon as there's oil on the patch they dig more holes, and the price of oil goes back down.

Dan Ferris: It's all they know, Porter. It's all they know how to do with money is put it in the ground, and put it in the boats.

Porter Stansberry: Let me give you guys, and, Dan, let me give you a tip I learned from Soros. So I read all of Saurus' books. Trust me, no one wants to have to do that. They're mind bogglingly boring, and self-obsessed. But he has one really good idea for these things, and he learned it from Druckenmiller. So Druckenmiller would go into a bombed out cyclical thing like you're doing, and they would buy two stocks. They'd buy the stock that they knew for certain would survive and would double, and triple, and quadruple, and they'd buy the one that they thought would barely make it. The one that you think will barely make it sometimes goes up 10- and 20-fold.

So their feeling was, "Look, if we're wrong about the one that doesn't make it, fine. We're going to double our money on the one that we know will make it. We'll come out even. A year from now we'll be at even. But if we get lucky we might be up 5X." So if your downside is I don't lose money, and your upside is 5X, I'll take the 5X. So you might want to try that. Now you'd want to differentiate for your Extreme Value readers. Look, this is the safe pick, and look, this is the maybe.

Dan Ferris: Yeah, we'll print that one in red.

Porter Stansberry: Yeah. Pairing those two together can be very interesting. If you're right about the cycle, the one that you think will barely make it often times makes it by a mile.

Now one last question for you, and then we've got to move on because Buck's got a hard stop. He's got to catch a train and go do something –

Dan Ferris: Back to the swamp.

Porter Stansberry: He's got to go to something secretive in D.C. I'm not saying he still works for the CIA. I'm just saying he has to do something secretive, and he has to leave in about 20 minutes.

Dan Ferris: Not a confirm nor deny, Porter.

Porter Stansberry: That's right. But Dan, I've got one question for you about this. So this type of investing appeals to me, and has appealed to me for 20 years. I've tried it. You and I have worked together on these projects. It's much more difficult to do in real time than it looks when you look retrospectively. When you look in the past, oh, this is the easiest thing in the world, but the cycles are never quite the same, and there are hiccups that you don't notice when you look back on the chart are big moves.

So if a stock has gone up like 10 times, when you look back at the chart it all looks flat. But in the meantime there's like six or seven 50% drawdowns in there, and those are really hard to survive if you're not 100%sure about the cycle. That you just, "Oh, I'm early." It's going to be harder than you think, and I know that you already know this.

Dan Ferris: Yeah, you don't have to tell how damn hard it's going to be.

Porter Stansberry: But the question I've got for you is, is there any easier way? In other words, can you find companies that have been beat to hell where they aren't in deeply cyclical industries?

Let me give you one example I've been working on. Under Armour, so Under Armour makes sports apparel, and they do it on a brand way, and they've got different channels. It's a very good business because people like Under Armour, and they've built a good brand, and it was really overvalued.

They had some problems because people stopped going to malls. So they had a channel problem. Meanwhile their online channel keeps growing, their international channel keeps growing, it's just their mall channel that got hit. Well you're going to survive, right? It's the old American Express oil scandal. You've got a big problem in your business, but it's not fatal.

And so it wasn't that hard to see that Under Armour trading from $10 to $15 was awfully attractive and a really good business suffering through a one-time kick in the shins. I have come around to think that that is a better thing for me to do as an investor than to try to figure out how to make leaking, rusting ships work. Any comment about that? I know you do both.

Dan Ferris: It is. That's why I basically swore off of this for a while.

Porter Stansberry: But now you're back.

Dan Ferris: I was never going to do this, but everything is bottom up, and I think that's a good way for me to stay. But you're right, those situations come up and I'd like to believe that we're all over them. We can't obviously get them all, but that's what I would prefer to find for sure, absolutely. I mean a real business and not this kind of crazy cyclical almost gamble, sure. I would prefer to find another Constellation Brands.

Porter Stansberry: Yeah, you've had lots of them. So do you think this turn in strategy for Extreme Value, or at least this part of your portfolio is in part a reaction to how overvalued stocks have become in general?

Dan Ferris: Absolutely.

Porter Stansberry: You've got to play the ponds that are still cheap.

Dan Ferris: Yeah, yeah. That's what I have to do otherwise I don't know where I am. It's like putting on a blindfold if I don't do that. So that's – I look for things that are cheap enough. We're a value investor. You know what that means. It means you get a good idea of what something is worth and you pay a lot less for it. Or you get an idea that maybe the market thinks it's not worth much. There are different subtle ways to sort of evaluate it, and that's what we do, and I can't buy Facebook, and I can't buy Amazon.

Porter Stansberry: Right, I wouldn't buy them here either. All right, well I wish you good luck.

Dan Ferris: We'll need it.

Porter Stansberry: And folks, if you're interested in Dan's unique investing style, which he has a great track record. He does very well overall. This is, I think, a risky strategy, but could be very, very lucrative, and it's working out so far.

Dan Ferris: Yeah.

Porter Stansberry: So it's extremevalueoffer.com. Extremevalueoffer, one word, extremevalueoffer.com to see our latest price on the valuable research of our friend Dan Ferris. Dan, thanks for joining us.

Buck Sexton: Thanks again everybody for writing into the mail mag this week. We appreciate when you fill the inbox with useful feedback. High fives to people like Mike L., Dana H., Tim V., Harry C., Dan S.R.B., and Brian G. That's just a few of the ones that sent their helpful thoughts and comments. Please keep them coming. Write to us at feedbackatinvestorhour.com.

Porter Stansberry: Mail baggery.

Buck Sexton: We got some mailbag time.

Porter Stansberry: Mail baggery. What could be in the mailbag today?

Buck Sexton: Going to get our mailbag out.

Porter Stansberry: Love us or hate us, just don't ignore us.

Buck Sexton: Regards everybody from a Joe M. Here's what he writes, "Porter, first off, love the podcast. I really enjoy the variety of guests you've had on as of late. Now as to the subject of this e-mail."

Porter Stansberry: But.

Buck Sexton: I could there was something coming.

Porter Stansberry: I could feel the but coming.

Buck Sexton: Yeah. "In response to another listener's question about position sizing for Stansberry's Credit Opportunities recommendations, you stated the higher the yield to maturity the higher the risk, and therefore you should put less capital into those positions relative to bonds with a lower yield to maturity. I think you are –"

Porter Stansberry: Uh-oh.

Buck Sexton: This is what he's writing, "100% bass akwards on this, Mr. Stansberry. Why?"

Porter Stansberry: Oh, wouldn't be the first time.

Buck Sexton: "Why? Well it's what you yourself have stated many times, and that is that the normal recovery for bonds is roughly 40 cents on the dollar. Using this figure, a Credit Opportunities pick closer to the 40 -cent level is safer. Were GM bonds safer at par, or at 50 cents? I argue it is the latter. I am curious as to your thoughts on this bass akwards line of thinking."

Porter Stansberry: Well, just for the record, I purchased GM bonds at 15 cents on the dollar, and at that point they were certainly much safer than they were at par. At 50 cents they really weren't safe at all. So honestly, that question was so long and involved, and it's corporate bonds, which are confusing in themselves. Let me just put it to you this way, we're at a moment in time and the markets right now where there is very little appreciation for risk, but that appreciation is growing.

So today, bonds that are trading at, let's say 75 cents, or 80 cents on the dollar, they are going to go lower. Riskier bonds are going to depreciate in value over the next six months. There's no question that's going to happen. The spread between corporate debt and sovereign debt, that is between the bonds on a company and the bonds issued the U.S. government, the spread between those interest rates is going to grow, and that will have the impact of lowering the price of corporate debt, so you're going to have losses in corporate debt.

So what I'm telling you is at this stage in the market, investing in risky bonds is going to be a poor bet. The other thing that I would ask you to realize is that the recovery data that I quote is meaningful, and that you can compare recovery rates in junk bonds from investment grade bonds, so junk-bond recovery rate is like 42 cents, and investment-grade debt recovery is like 46 cents. So the interesting thing is that even though there's a large perception of risk in high yield, it's not that much risky than investment grade.

That will remain true, but the thing you have to understand is those are averages. Those are averages. That is not a guarantee. And unless you have done a lot of homework, you can't know what the recovery will be. Some of the bonds we've recommended in Stansberry's Credit Opportunities have a known recovery rate of zero. So if we're wrong and the bond defaults, we would expect recovery of zero, and those are risky, risky bonds. Much more like buying a stock. And we're hopeful that the return we're going to earn is worth it, and we're hopeful that our analysis is correct.

But I think you're making a very big mistake by assuming you're not taking a big risk in an individual given bond simply because the average historical recovery has been 40 cents on the dollar. That is meaningless when you're trying to evaluate the risk that you are taking in any specific bond. Let's go from there.

Buck Sexton: All right, next up in the mailbag this week we've got James G. He writes, "Hey, Porter and Buck, I love the show. I'm constantly learning from you and your high-caliber guests with their financial market insights and thoughts. I'm now a subscriber," yeah, there we go, "And believer of Porter's idea of an impending Debt Jubilee. I was wondering what your thoughts were on economist Steve Keen's view in a recent interview where he stated that if he were the chairman of the Fed he would initiate a modern Debt Jubilee. Keen would use the Central Bank's capacity to create money to make a per capita injection into people's bank accounts under the provision that the funds would be used to pay down personal debt. Bar the downside of penalizing savers and encouraging financial irresponsibility on a personal level, Keen believes this wouldn't create massive inflation. Thoughts, and looking forward to your answer, and keep up the great work. From James."

Porter Stansberry: If only it were true. People sadly never get over the Santa Claus myth. You cannot create, what would that be paying off all your personal debts, like – that's at least $3 trillion, student loans, car loans, credit cards, not even talking about mortgages. So $3 trillion of consumer demand instantly overnight. Here's a question for you Buck. If that happened, if the Fed gave $100,000 to every individual in the country under the age of 40 who owed money on a credit card, or a debt, or a car, or a student loan, and you could only use it to pay off debts. You couldn't go buy something new. What would the stores run out of first?

Buck Sexton: Products. What do you mean?

Porter Stansberry: I'm just asking. Like if the average 30-year old woke up tomorrow, and basically you're essentially giving him access to another $100,000 in credit. Because as soon as he pays off those loans what's he going to do with the available credit?

Buck Sexton: Consumer goods.

Porter Stansberry: He's going to go buy new stuff.

Buck Sexton: Yeah.

Porter Stansberry: So what would the stores run out of first? We're talking about $3 trillion overnight in additional consumer credit.

Buck Sexton: Flatscreen TVs and clothing?

Porter Stansberry: The boys in the booth said, "Booze."

Buck Sexton: Oh, OK.

Porter Stansberry: It would be a great time to own Applebee's stock, or Buffalo Wild Wings, or I don't know. I can't even imagine what people would run out of first. I think it depends on what neighborhood you're in would see what you'd run out of first. Rims in some neighborhoods. "I got my new rims." Anyways, the idea that you can create wealth out of thin air is just absurd. So yes, it would cause an enormous inflation, enormous. And it would cause people to flee from the dollar, which would be bad.

Buck Sexton: Yes, it would. All right, next up, Matt writes, "Gentlemen, an American Jubilee." Ah, somebody who read through the book and now has a question based on it. "Porter identified FCX as a company with a trophy asset in the form of the Grasberg mine in Indonesia. What do you make of Freeport... McRowin's... 2017 discussion –"

Porter Stansberry: Freeport McMoRan's.

Buck Sexton: Oh, I've never seen that before, so that was a tough one for the Buckster. Freeport McMoRan's.

Porter Stansberry: McMoRan. Freeport McMoRan.

Buck Sexton: Fair enough. All right, I was like that's a tough one to say. "McMoRan's 2017 discussion to sell the mine or reduce their stake. What do you make of the savaging they just took when their earnings fell short? Not to harass you for free advice – "
Porter Stansberry: Oh, of course.

Buck Sexton: I feel a but coming on here.

Porter Stansberry: Yeah, so but, but.

Buck Sexton: "But is a 15% drop in stock price the classic opportunity a value investor looks for? Thanks so much. Love the show. From Matt." The man himself.

Porter Stansberry: I don't really feel confident discussing Freeport McMoRan in detail right now because I am not up to speed on it. I haven't studied it directly in several years. And the analysts that do that for me are not present, so I can't answer that question. I can tell you that the stock has gone from $4 to $20 in the last two years. So a pullback of 15% is not material to most investors in the stock. If you happen to be a recent investor it's probably very material.

Buck Sexton: Love us or hate us, just don't ignore us.

Porter Stansberry: Buck, go catch your train and do your secret stuff in Washington.

Buck Sexton: Thanks everybody for listening. Excited to join you next time.

Announcer: Thank you for listening to the Stansberry Investor Hour. To access today's notes and receive notice of upcoming episodes, go to investorhour.com and enter your e-mail. Have a question for Porter and Buck? Send them an e-mail at feedbackatinvestorhour.com. If we use your question on air we'll send you one of our studio mugs. This broadcast is provided for entertainment purposes only, and should not be considered personalized investment advice. Trading stocks and all other financial instruments involves risk. You should not make any investment decision based solely on what you hear. Stansberry Investor Hour is produced by Stansberry Research, and is copyrighted by the Stansberry radio network.

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