Recession Is Here And That’s Good News
The last time Target missed earnings this badly was in the summer of 2022.
That began a very weak period for stocks. The stock market and the bond market fell sharply through October of that year. Big tech stocks, like Netflix (NFLX) and Meta (META), fell 50%. It was the worst period for bonds in more than 40 years. Even hedge funds designed to protect investors, like Bridgewater Associates’ All-Weather fund, saw huge declines, down more than 20%.
The previous notable big earnings miss for Target was in the first quarter of 2015.
And, while most investors have forgotten, that miss too marked the beginning of a weak period for stocks and corporate bonds.
Peak-to-trough from early 2015 through early 2016, stocks fell 19% – just missing the official decline for a bear market. Even more notably, in 2015 the corporate bond market declined.
For a brief period in late 2015, high-yield bonds offered almost a 10% premium in yields compared to U.S. Treasuries. It was a period of notable distress for investors in the oil and gas industry – and, thus, incredible opportunities.
Seeing this opportunity, I launched a distressed-credit advisory, Credit Opportunities. And we went “shopping” in the energy sector.
Our very first recommendation, in November 2015, was to buy both the shares and the bonds of Natural Resource Partners (NRP).
This company owns an enormous portfolio of royalties on coal mines.
Where other investors saw an industry in permanent decline and a company in financial distress, we saw an inevitable recovery because of the critical role coal plays in both electricity and steel.
We also knew that the company’s bonds were “money good” because it owned more than enough assets to repay us in full, even in the event of a bankruptcy.
Thus, from our perspective, there was zero risk in buying these bonds. And the stock, while volatile, was trading at such a low price that if the market for coal didn’t disappear permanently, we stood to earn outrageous returns. To hedge the extreme volatility of the shares, we recommended buying a blended position: 75% in the bonds and 25% in the stock.
The bonds were trading at more than a 30% discount to their face value – $675.80 for each $1,000 bond. And stock was around $15 a share (since adjusted by a 1-for-10 reverse split).
We were a little early. Three months later, in early 2016, the stock bottomed at $5 per share. On paper, the stock was down 75%. Was this a disaster in the making? Not at all. The bonds didn’t budge. And we knew it was only a matter of time until the market saw what we saw: a very capital efficient business with an incredibly resilient product.
About a year later, the picture looked very different.
In February 2017, we were able to sell the bonds at a premium to face value ($1,005), booking 62% total return in about 15 months. There is something unbelievably satisfying about earning better than equity-like returns on risk-free bonds. But, that wasn’t the best part. The best part was we’d been smart enough to buy the stock too. Shares of NRP have gone up more 1,000% since then, for annualized returns of 32%.
This is exactly why we look at recessions and corporate distress as good news.
To be able to acquire these kinds of distressed assets, you have to understand that there’s a corporate credit cycle. You have to know where you are in that cycle. And you have to be wise enough to have cash when these opportunities emerge.
I strongly recommend taking steps now to hedge your portfolio and to raise cash.
What stocks should you sell? My recommendation is to look at your portfolio and identify which companies haven’t been performing well over the last five years. Simple test: how much has revenue grown over the last five years? We’ve experienced a huge inflationary boom. Did the company participate?
Here are several companies that haven’t performed well and their average revenue growth over the last five years:
- Hasbro (HAS, -4%)
- 3M (MMM, -4.6%)
- Intel (INTC, -7%)
- AT&T (T, -7.5%)
- Principal Financial (PFG, -7.5%)
- Aflac (AFL, -12%)
- AIG (AIG, -12%)
After identifying companies that haven’t performed by an objective measure, the next step is to see if there’s an obvious reason why they haven’t.
In Target’s case, that’s easy. There’s an Amazon-sized elephant in the room. The chart below shows how Amazon’s (AMZN) revenue overtook Target’s revenue in 2014 – a decade ago. On a relative basis Target has lost ground to Amazon every year for more than 20 years.
Don’t own stocks like these.
As this recession develops, we’ll continue to recommend shorting weak businesses in The Big Secret on Wall Street. We’re making our second such recommendation tomorrow. These positions will help to hedge against the temporary drawdowns in our other, high-quality investments.
The other thing we’ll do, of course, is look for outstanding distressed opportunities in great companies, like we did with Natural Resource Partners in 2015. And today we have a huge advantage: our distressed-debt analyst Martin Fridson, who runs our Distressed Investing advisory. Marty is the most acclaimed research analyst in the history of the high-yield market. There’s no one better to help us find these amazing “money good” opportunities.
So, I hope you’ll stay tuned. And, if you aren’t yet, please consider joining with us at Porter & Co. as a Partner Pass Member. Yes, it’s an investment in us. But it will pay great dividends for you across your investing lifetime.
Regards,
Porter Stansberry
Stevenson, MD
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