Sunday, April 28, 2024

When Recession Strikes, Distressed Pickings Rise

In today's Masters Series, originally from the November 24, 2023 issue of Distressed Investing at Porter & Co., Martin talks about the signals he's seeing in the economy that point toward an upcoming recession... details how this crisis will impact the bond market... and discusses how you can position yourself to profit from this looming market chaos...
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Editor's note: An economic disaster is approaching... But you can profit from the pain.

Porter & Co. senior analyst Martin Fridson says history shows we're bound to enter a recession at some point in the near future – if we're not already in one. According to Martin, this crisis will set off a wave of bankruptcies that will create some of the best distressed-debt opportunities you've likely ever seen...

In today's Masters Series, originally from the November 24, 2023 issue of Distressed Investing at Porter & Co., Martin talks about the signals he's seeing in the economy that point toward an upcoming recession... details how this crisis will impact the bond market... and discusses how you can position yourself to profit from this looming market chaos...


When Recession Strikes, Distressed Pickings Rise

By Martin Fridson, senior analyst, Porter & Co.

Economic indicators suggest that the opportunities in distressed debt are about to become more numerous.

That's because the number of bonds trading at distressed levels multiplies dramatically during recessions – and many signs point to an upcoming recession.

The chart below tracks the distress ratio – defined as the percentage of bonds in the ICE BofA U.S. High Yield Index trading at 10 percentage points or more above Treasury rates. A risk premium that big indicates that the market – rightly or wrongly – sees a high likelihood that the bond will default within 12 months. Since December 1996, the distress ratio has averaged 10.5% during nonrecession months and 39% during recession months.

The distress ratio is on the rise once again after dipping between March and August 2023. This makes sense as unemployment continues to weigh on the economy – reported at 3.8% for last month. Unemployment is just one of 10 leading economic indicators tracked by the Conference Board, a nonprofit research group that publishes a closely watched list of economic data.

The index consisting of all those indicators has now fallen for 15 straight months. It would be unprecedented for a downward streak that long not to culminate in a recession. Uninterrupted streaks ranging from 18 to 28 months preceded and continued into the recessions of 1973 to 1975, 1980, 1981 to 1982, 1990 to 1991, 2001, and 2008 to 2009.


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Another data series closely followed by distressed-bond investors on the lookout for a recession is the difference between yields of two-year and 10-year Treasury bonds. When the two-year rate is higher than the 10-year rate, as is the case currently, the yield curve is inverted. Recessions generally follow yield-curve inversions, although there have been brief and modest inversions that were not followed by recessions.

Some market participants are dismissing the notion that the current yield-curve inversion is a foreshadowing of a recession on the grounds that the curve has been inverted since July 2022 without evidently leading to a recession. The flaw in that argument is that past recessions began after the inversion ended.

For example, the Treasury yield curve was inverted from February to December 2000, but the economy didn't slide into recession until April 2001. Similarly, the yield curve was inverted off and on from December 2005 to June 2007, and the great financial crisis didn't begin until January 2008.

There's no way of analyzing these statistical series to determine exactly when the next recession will occur. But don't rule out the possibility that it has already started.

Economist and former Federal Home Loan Bank of San Francisco Chair Robert Barone expressed his belief a few months ago that the National Bureau of Economic Research – the organization that officially determines dates of the business cycle – would name the fourth quarter of 2023 as the beginning of a recession. He cited several data points, including banks' current record-high rate of denials for increases in credit-card limits.

Whatever the start date of the recession ultimately turns out to be, it's predictable that the distress ratio will rise dramatically. Even in the brief pandemic-driven recession of 2020, the ratio jumped from 12.3% in February to 27.8% in April before the Federal Reserve flooded the system with so much credit that it became almost impossible for companies to default.

History tells us that when the distress ratio triples or quadruples from its current 8.1%, the list of distressed issues will include many bonds of companies experiencing temporary operating difficulties, but that have sufficient financial resources to remain in good standing on all their financial obligations.

As we navigate through a recession and eventual recovery, we'll be on the lookout for bonds that will have the potential to rack up price gains of 50% or more – while also throwing off massive yields...

Regards,

Martin Fridson


Editor's note: Stansberry Research founder Porter Stansberry predicted the 1998 emerging market crisis, the 2008 financial crisis, and last year's banking collapse. And he recently stepped forward to share an urgent warning about an upcoming crisis that no one in the financial media is talking about...

Porter held an online presentation to talk about how this looming event could split the market in two. Plus, he shared how this rare setup could offer the greatest moneymaking opportunity of your lifetime if you understand how to prepare for it. Click here to learn the full details about this unique situation...


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