Blue Chip Cracks ➡️ Great Reversal INTO America 2.0
Forget inflation. THIS will set interest rates and markets in the future.
Cracks are showing in America 1.0 blue chips. Those stocks are going from “safe-havens” to a danger zone.
That’s a bullish scenario for us — and our America 2.0 stocks and crypto.
See how the Great Reversal is unfolding now:
I also posted about this on Twitter. You can read the full thread here. And be sure to subscribe for more!
This is going to be controversial. I am probably going to get hit by trolls who say, “Paul, you’re avoiding the problem. You’re trying to focus on something to hide the fact your stocks have gone down. We had a poor year in 2021 and having a poor year in 2022.”
That’s OK. I feel like this is important. So I am going to make this video. It’s a little difficult, it’s complicated, but I think it’s important. Most of all, you’re not reading about this anywhere else. You can go all over YouTube, Twitter, Wall Street Journal and New York Times.
Let’s Look Into Bloomberg’s Article!
Unless you are very sophisticated and reading a lot of news sources like the way I read them, I doubt you would see this. Let me start off with this article from December 16, 2020. We are going to put up the headline:
“America’s Zombie Companies Rack up $2 Trillion Worth of Debt.”
It refers to the period right after the Federal Reserve cut interest rates and said they were going to intervene in markets so as to keep them liquid. It stimulated a borrowing boom. This article says, “The borrowing boom amid the pandemic reshapes corporate finances.”
Then, it gets to the part that is problematic. “Surge in zombies is expected to weigh on U.S. economy for years.” I am going to read a little from the text of this article which is behind a paywall at Bloomberg. I’m going to read some because it’s important and it gets to the heart of a number of things I’m going to get to.
I’m just going to give you fair warning: This video is going to go on for some time. If you’re not interested, don’t care, then it’s time to tune out and find something different to do. Bloomberg says,
“They were once America’s corporate titans, beloved household names case studies in success, but now they are increasingly looking like something else — zombies — and their numbers are swelling.”
Then the article goes on to name some of these zombie companies. These are big companies, brand name companies that you think of as being blue chip stocks. Not all of them, but many of them.
“From Boeing, Carnival Corp., Delta, ExxonMobil and Macy’s, many of the nation’s most iconic companies aren’t earning enough to cover their interest expense, a key criterion, as most expert market analysts define it, for zombie status.”
In other words, when a company goes to the bond market and borrows money from investors who give them money, and in exchange the investors get a promise that the company will pay it back in three years, five years, whatever the number is, and they also get interest payments.
Those interest payments have to come, you would hope, from the company’s operations. Bloomberg went and looked at the companies’ interest expenses and then looked at their earnings which are driven by sales and cash flow. They computed that these companies, based on the amount of debt they have, they can’t pay their interest expense.
So they are forced to do one of three things. One might be to cut costs to try to generate more cash from their existing operations. Borrow even more to kick the can down the road if you will. I’m going to update some of the numbers that are here. In the analysis in this article, they put up this chart.
It says, “Undead Debt.” This is dated. These numbers have gotten worse. Truthfully I lack the team or the staff to be able to update these numbers. The graphic says zombie firms are sitting on an unprecedented $2 trillion of obligations. You can see that these numbers are stark.
The chart goes on to show that more than 700 firms in the Russell 3000, which is a very large index made up of companies of all size, face interest coverage ratios below one. In other words, they are not making enough money to pay their debt.
Going back to the companies they mentioned — Boeing, Carnival, Delta, Exxon and Macy’s — I just went back and updated the amount of debt they had before the pandemic started and where they are at the end of December 2021.
Boeing when the pandemic started had long-term debt of $19.8 billion. By the end of December 2020, they had $61.75 billion. They seem to have paid off or some of it has become current. They have slightly less at the end of December 2021 at $56.7 billion.
Carnival had $9.68 billion at the end of 2019. It jumped to $22.13 billion by the end of December 2020. Today, as of the end of December 2021, it’s at $28 billion. It’s jumped by $19 billion.
Delta had debt of $8.87 billion as of December 2019. $27.42 billion as of December 2020. $25.14 billion at the end of 2021.
ExxonMobil, $19.24 billion at the end of 2019. $24.67 billion at the end of 2020. And an amazing $45 billion at the end of 2021.
Finally Marcy’s. These numbers were difficult to piece together because it does look like Macy’s increased the amount of debt, but it seems like it was somewhat short term. If you look at the numbers you might find slightly different numbers. It looks like they started 2019 with $5.1 billion.
It does look like, at least per the numbers, they had slightly less debt in 2020 even though there are other borrowings that don’t show up under long-term debt. At the end of December 2021, they are still at something like $4.4 billion in long-term debt. Based on a quick analysis, what has happened here is even more distressing in the sense that it seems like more of the debt has now become short-term in nature.
In other words, they are going to have to pay this back sooner rather than later. If what I’m about to go over with you is correct, this is a set of tweets I did yesterday. I started one tweet by putting this article out. I said,
‘While the headlines are about inflation, this is the problem that’s going to matter going forward and what is going to set interest rates and markets in the future.”
Is Inflation Temporary?
Just to go back to this article again, it ends with some analysis which today seems like these people are delusional and stupid. It’s what I’m seen as today because of my call saying believe inflation is temporary and interest rates are going to go back to quite low levels, negative levels.
They are already at negative levels, so even more negative levels. The article says, “Still, corporate deleveraging in the years ahead will result in slower growth due to inflation and low rates for as long as the eye can see.”
Let me repeat that. So the end of the analysis after showing people the data, people who are in the fixed-income markets who are sensitive to inflation because it destroys the value of what they’re going to get back when they lend money in the bond market and are also sensitive to credit risk.
The risk they face is that the company cannot afford to pay them back. I believe this is the actual risk in the market. In one of my tweet streams I wanted to connect why this is important to us. It’s because there’s a lot of data that is signaling that the bond market is no longer willing to buy the bonds of Boeing, Carnival and Delta and others that are zombie companies.
They can see these companies are running out of time. If the Federal Reserve is talking about raising interest rates, they’re not going to buy their bonds. That’s going to present a significant risk for these bondholders.
The reason this matters to us is if that is right, that means there is a big shift coming in terms of the stock market and liquidity. People are going to want exposure to growth again. The growth companies, as I have mentioned, don’t have large amounts of debt because nobody would lend to a growth company.
They lack the kind of long-term history that bondholders want. They lack the stable, free cash flow characteristics that bondholders want. Most of the companies are still unprofitable, reinvesting all their money and usually raising money in the stock market to fund their operations.
I believe we are setting up to see a massive reversal soon where these blue chip companies, some of which are seen as steady eddie, dividend-paying stocks, are going to go through a transformation as being quite dangerous from their current status of being safe.
Our stocks, which have been called risky, dangerous, terrible, set up to fail, are going to see the flow of money come in and bid them higher. This process seems to have started already. The next tweet stream goes into why I believe this is the case.
These cracks that appeared in Boeing, ExxonMobil, Carnival and others are spreading. We have seen this in the last quarter. I briefly touched on this. Stocks like Clorox, 3M, Honeywell are making 52-week lows. That’s dissonant on the market.
When you go look at their financials, they are showing similar credit risk pressure. These are companies that have borrowed a lot of money. The market can see they are going to struggle to make their interest rate payments. You can see this if you look at this chart, which is current data.
It says investors are pulling money from U.S. high-yield bonds. High-yield bonds means they are paying more. People who are selling bonds in the high-yield market usually have to pay a much higher interest rate than investment-grade bonds.
Oftentimes, this is the place where people will start to shed risk. In other words, sell their holdings. That’s exactly what has been going on for some number of weeks now as you can see by the chart.
The next thing you can see that’s pointing to this unfolding as we speak is that the corporate bond market, as evidenced by the iShares iBoxx Investment Grade Corporate Bond ETF, is now showing a one-year loss of nearly 6%. It doesn’t sound like a lot, but I can tell you for the bond market it’s a big deal.
For investment-grade corporates to show that kind of loss is telling you there is some serious pressure. What I believe I going to unfold and is actually unfolding is there is a giant surge of money that is exiting bonds who have seen these corporate bonds issued by supposedly safe-haven companies as being safe yield.
Someplace where you can go park your cash. Also, from dividend-paying stocks. There are a lot of people talking about how now is the time to buy dividend-paying stocks. I would tell you you are putting yourself in peril. That’s opinion, not advice. I want to make that 100% clear: Opinion, not advice.
Where Is All The Companies Money Going?
If my analysis is right and these companies are facing serious financial pressure that you can actually go and see on their balance sheet, income statement and free cash flow statement, where is this money that is sloshing around likely to go? I believe one place it could go is U.S. Treasuries.
The U.S. government has plenty of demand still for U.S. Treasuries despite fears of inflation. The 10-year bond is still far better returning than any other country, whether it be Germany or Japan or anyplace else. There is an absolute market for it.
The other place is mortgage bonds backed by our real estate markets backed by 30-year mortgages. Over the vast history of time that has been a reasonable place for people to have put money into. Again, opinion, not advice. I’m not telling you to do this, I’m just telling you these are the places I see.
Then, some of this cash is going to be forced up the risk ladder. They are going to say, “I can’t put that much money into treasuries because the yield is too low. I can’t put that much money into mortgage bonds because I am going to end up bidding the prices higher and getting lower and lower returns.”
They are going to be forced to come and buy growth stocks and small=cap stocks because those are the stocks that have been innovating. Those are the stocks that can grow as a result of innovation, new markets that are unfolding as we speak. They just don’t have the problems of America 1.0.
In the tweet I anticipate an objection people have: Why can’t people just stay in cash? Well, because interest rates in real terms after you subtract inflation have been negative for many years now. You don’t’ experience it that way, but if you are getting 0.1% at the bank and inflation is 2%, your actual rate of return is -1.9%.
If you are managing billions of dollars you can’t leave the money in cash. You have to get some kind of return that gets you at a lesser loss or breakeven. Or, if you can, positive returns. You add one more layer to this. Imagine the Fed is going to start seeing these problems happen in the bond market.
These crack that are appearing with Boeing, Carnival, Clorox 3M and other companies. At some point in time they are going to come off their current track to want to raise interest rates as much as they want to or as fast as they want to. As well as, think of the potential impact of what it’s going to have on these zombie companies and think there’s going to be a significant impact.
How Does The Bond Market Work?
I can tell you that the bond market is very sophisticated. There are far fewer retail investors in the bond market. They are difficult to buy. These are high ticket investments. Every bond is denominated at $1,000. You can’t buy and sell very easily.
This is a much more sophisticated market. The folks in this market are buying insurance using credit derivatives. That means they are looking at the scenario and they are seeing risk. They are starting to go and buy insurance so if this starts to come undone and they are facing credit risk, they get paid for it.
There is a market for these kinds of derivatives you can buy that these sophisticated investors know about. You can see by the lines on this chart that this is what they’re doing.
Bottom line to this entire video is not gloom and doom for our stocks. I believe this is setting up for a very bullish scenario for us. At the end of the day, what is seen today as an unmitigated benefit is a dividend stock. A company that is buying back stock has a major problem if they are not supported by their underlying business.
If that dividend is supported by a stock that has been bought back using debt and if the company is incapable of paying their interest income, the bond market is getting ready to say, “Hey, no more. We are full and we aren’t going to buy it.” Now begins a problem for them.
They need to keep refinancing those bonds. If the market says “no more” it’s a major problem for those companies and those stocks. However, given that there is plenty of cash in the system — I saw a number that said $1.8 trillion in the system — I don’t’ believe there will be a systemic crisis of any kind.
Instead what you are going to see is a massive asset allocation shift away from these kinds of corporate bonds of companies that are zombies, their stocks — which many people own for their dividends — and into growth stocks, America 2.0 stocks, Fourth Industrial Revolution stocks.
The other place it’s going to go is crypto. I know this was complicated. I know this was long. However, I felt it was important. I know some of the tweets might come across jumbled. For me to read every tweet would have been too long. Nonetheless, I hope you get the gist of the point.
There is a major transition unfolding. Not going to unfold, unfolding. It’s away from zombie companies, their bonds and stocks and into growth stocks because they don’t have the issues these companies have. They have no growth. As a result of that, they have no long-term future.
I believe that’s going to lead to a massive allocation into growth stocks because they don’t have those problems, and into crypto, which is exactly where we are positioned. I am still very bullish, optimistic, positive. I would tell you if you are in our stocks to be strong hands.
Hope you liked it. Come back next week. This is Paul saying bye.
Editor, Profits Unlimited
P.S. Get ready for the Great Reversal INTO America 2.0 stocks. My full strategy here.