Edward Altman is better at predicting corporate bankruptcies than anyone else in the world.
And his latest prediction is chilling…
The New York University professor created the famous “Altman Z-score” in 1968. The 52-year-old formula assigns a number to a company based on several financial variables.
It’s so reliable as a credit-strength test, hedge funds and investment managers often use it when analyzing a company.
When it comes to the recent market turmoil, Altman isn’t mincing words…
In an interview with Yahoo Finance in March, Altman warned that – in terms of the amount of debt that will go bad – we’re headed for the worst period for corporate defaults that we’ve ever seen. He expects $150 billion in high-yield (or “junk”) bonds to default.
It might even be higher than that.
Due to the coronavirus pandemic, the world’s economies have ground to a halt… At the same time, oil prices have collapsed to less than $25 per barrel. With corporate debt at an all-time high and credit quality at an all-time low, it’s simply a recipe for disaster.
But you don’t have to be a victim. We’re seeing a wave of opportunities right now in a corner of the markets you might never have considered.
And it could make all the difference to your wealth in the years ahead…
We don’t know when the coronavirus lockdown will lift or when business will get back to normal again. But things are likely to get much worse in the months ahead.
A global recession – two consecutive quarters of declining gross domestic product – is all but a certainty now. The only question is whether it will develop into a depression (a decline that lasts for years).
Either way, we can expect a lot of companies to default on their loans in the months to come…
At the start of 2020, credit-ratings agency Standard & Poor’s (“S&P”) forecast a 3.3% high-yield default rate. That’s the percentage of companies with “junk” credit expected to default within 12 months.
Less than four months later, it’s now forecasting a 10% default rate.
S&P has never increased its forecast so drastically. And its current “pessimistic” forecast projects the default rate to reach about 13% by the end of the year. That would be a new 40-year high.
The high-yield credit spread started the year at 360 basis points (“bps”). By late March, it soared to more than 1,000 bps, the highest it has been since 2009. It has since fallen down to around 900 bps today.
Don’t expect that dip to last long. We expect it to go higher… During the last credit crisis back in 2008, the credit spread peaked at 2,200 bps. As the default rate climbs over the next few quarters, S&P believes the credit spread will approach 1,600 soon.
What does this mean for the bond markets? It means that corporate-bond prices have collapsed.
However, you must understand this… Not every company with a bond that sold off will default.
This is the type of environment we’ve waited for since we launched Stansberry’s Credit Opportunities back in November 2015. Our strategy is to buy bonds when they trade at large discounts to par value.
If you’re not familiar, bonds are nothing more than loans to companies. They are typically issued in increments of $1,000. This is known as the “par value” or “principal.” Bonds pay regular interest payments twice a year… And the $1,000 of principal is paid back on a set future maturity date, usually 10 years from when the bond was issued.
Here’s what’s important to remember… a bond constitutes a legal promise to repay. When a company issues a bond, it guarantees it will pay you back all of the principal and the interest you are owed. If it doesn’t, it will be considered in default and enter into bankruptcy.
When the bond comes due, you’re legally entitled to collect the full $1,000… regardless of what you paid for it. And you’re also entitled to the regular interest payments along the way.
With stocks, companies make no promises about dividends or returns.
Buying bonds at large discounts to par value is lucrative – and much safer than buying stocks. Bondholders sit higher in a company’s capital structure than stockholders. That means if the company goes bankrupt, bondholders get paid before stockholders. In bankruptcy, stockholders usually lose everything. But bondholders typically recover at least some of their principal… historically around $400 of their $1,000 par value.
This is an exciting time to be a distressed-debt investor…
In recent weeks, thousands of bonds have seen their prices collapse. This happens when the market is concerned that companies will default on their debt. In situations like we’re seeing now, even companies that are perfectly capable of repaying their debt have seen their bond prices beaten down.
We’ve been studying these bonds… And we’ve found many that are great opportunities to put money to work in today.
These are companies that are built to survive a recession. They produced solid cash flows heading into the recent crisis. They all have strong balance sheets, a lot of liquidity, and manageable debt maturities over the next two years.
Nearly all of these bonds traded for more than par value in February. We expect many of them to return to par or higher over the next year or two… once the economy shows signs of improvement.
As we said earlier, we believe this is just the beginning of the crisis. If we’re right, this could be only the first wave of great opportunities. So be sure to keep a lot of cash as “dry powder.”
You could see some of the best opportunities of your lifetime in the coming months…
Good investing,
Mike DiBiase with Bill McGilton
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Source: Daily Wealth