Bear Market Signal #7

Bear Market Signal #7:

This Three-Letter Acronym Means "Financial Weapons of Mass Destruction" May Be in Your 401(k)

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You've probably never heard of collateralized loan obligations (CLOs). But they may be in your retirement account or pension fund as a "safe" investment option...

CLOs are a type of "securitized" asset, where debt — in this case, business loans — is pooled together, sliced up into tiers, and sold off to investors. This process is incredibly complicated, but a key point to understand is that it allows managers to package up lower-quality debt (much of which is rated worse than investment-grade) and sell it to investors as higher-quality — even "triple-A"-rated — debt.

In theory, because each investor gets a tiny piece of many different loans, risk is reduced. The securities are also ranked in tiers (or "tranches") based on the quality of the underlying debt, again reducing risk in theory.

We say "in theory" because it was this same model with securitized mortgage loans that blew up the last crisis. Warren Buffett called one type of these leveraged, securitized assets — specifically collateralized debt obligations (CDOs) — "financial weapons of mass destruction."

The CLO leveraged loan market is thought of as safer than CDOs... As Barron's recently reported, while CDOs melted down in the last crisis, CLOs were mostly made up of more senior loans. They didn't suffer the same cascade of defaults. And that's made CLOs more popular today.

Stansberry Research senior analyst Mike DiBiase reports the CLO leveraged loan market recently hit $1.6 trillion, double the amount at the end of 2008.

Investors like these loans because of their floating interest rates. As interest rates rise, these loans pay more interest...

What's troubling is that there is no direct oversight of the leveraged loan market. And it's not just banks that are extending these loans and repackaging them.

"Shadow banks" have emerged to get into the game. Shadow banks are investment companies like broker-dealers and private equity investment funds. They tend to focus on the middle-market, smaller companies that the bigger banks won't bother with.

Yield-hungry investors have been snatching up these loans in droves, ignoring the similarities to the subprime mortgages that triggered the last financial crisis.

While bankers receive big fees for issuing the loans, the Washington Post reports that many of these companies could be unable to repay their debt if the economy slows or interest rates rise.

When that happens, Mike expects the next crisis will begin in the less-regulated markets like leveraged loans, where we've seen crazy rates of growth... Then it will quickly spread to the high-yield corporate bond market... and then into the stock market. Share prices of highly leveraged companies considered safe today will crash.

In fact, former Federal Reserve chair Janet Yellen said:

This means that the next downturn that we have could be more serious and longer-lasting and more difficult to deal with than it would have been if we had constrained these practices.

And Timothy Long, the former chief national bank examiner at the Office of the Comptroller of the Currency, noted that as a downturn begins and these loans unravel, bankers will likely shut off the spigot quickly — leading to layoffs, bankruptcies, and fewer new investments. As he said:

"We are in the eighth year of a seven-year credit cycle... When things turn, they are going to turn hard."

Make no mistake: A crisis is coming. It could be far worse than what we saw in 2008. And if you wait until the signs are obvious to take shelter, it will already be too late.

The time to prepare is now. That's why we're holding a special event this week. On Wednesday, May 15, at 8 p.m. Eastern time, Stansberry Research founder Porter Stansberry will sit down with legendary investor Jim Rogers to explain exactly what you can do now to protect your savings — and even profit — while most folks are panicking.

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Our 8th Bear Market Signal focuses on a proprietary indicator that Porter Stansberry and our research team have developed. We've been following this for years and it’s painting a pretty bleak picture about the markets going forward. Click the "Bear Market Signal #8" button below to learn more.

Special Guests

Jim Rogers

Jim Rogers

Jim Rogers is an American businessman, investor, traveler, financial commentator and author based in Singapore. Rogers is the Chairman of Rogers Holdings and Beeland Interests, Inc. He was the co-founder of the Quantum Fund and creator of the Rogers International Commodities Index.

Porter Stansberry

Porter Stansberry

Porter Stansberry founded Stansberry Research in 1999 with the firm's flagship publication, Stansberry's Investment Advisory. He is also the host of Stansberry Investor Hour, a weekly broadcast that has quickly become one of the most popular online financial radio shows. At Stansberry Research, Porter oversees more than twenty of the best editors and analysts in the business, who do an exhaustive amount of real-world, independent research.

Austin Root

Austin Root

Austin Root is editor and portfolio manager for the Stansberry Portfolio Solutions products and American Moonshots. He is also director of corporate development at Stansberry Research and a senior analyst for Stansberry's Investment Advisory.