Video Update: Don’t Start the Celebrations Just Yet...

Today, headlines are cautiously optimistic about March’s slowed rate of inflation.

But let’s not forget, that’s just compared to the previous month. We’re still over 8% higher than we were this time last year.

This means the Fed is still likely on pace to cut interest rates at least once more in the coming months. And we want you – and your portfolio – to be ready for that possibility.

We’ll have more to say about this inflation reading in next week’s update.

Meanwhile, in today’s video update, Chief Analyst Adam Galas shares why there’s still a strong chance a recession is likely coming soon and what you can expect.

He’ll also dive into one of our Fortress picks that can weather this storm and how resilient it can prove to be, given even the most volatile market conditions.

Click the image below to watch the video or scroll down to read the transcript.

Happy SWAN (sleep well at night) investing,

Brad ThomasEditor, Fortress Portfolio

Welcome Fortress Portfolio members to another weekly video update.

Today we’re talking about why a recession is likely coming soon and what you can expect.

The economic data right now shows the recession is likely to begin in 2 to 4 months, probably around July.

The bond market agrees, and is expecting the Fed to pause at 5% and then start cutting interest rates by July because of the incoming recession.

Now, the good news is the job market remains strong with over 1 million jobs created in the last three months and 236,000 last month.

But it’s important to remember that this jobs report is based on a survey that always stops on the 12th of every month.

That means that the last strong jobs report ended on March 12th, just four days after the banking crisis began.

The good news is the banking crisis has calmed down. In fact, regional banks have actually seen $6 billion of deposits come back.

But for the industry as a whole, banking deposits are still leaving checking accounts and headed for the money market.

Now, that’s not unexpected. After all, checking rates are still 0.2%, while the money market yields over 4%.

The problem for banks is this means higher funding costs, and that’s likely why they’re pulling back on lending.

At the end of last year, we saw bank lending standards rising to average recessionary levels.

And in the last two weeks of March, we can see that bank lending decreased by $105 billion, which is the sharpest two week decline since 1970.

In other words, we’re facing a mild credit crunch, which could be a prolonged event due to the banking crisis.

That’s good… Because its causes are similar to the savings and loan crisis of the 1980s.

Back then, of course, the Fed hiked rates to 20% and greatly increased the cost of bank funding. So over the next 13 years, 30% of savings and loans failed, and Congress had to bail out the industry.

But, the good news is this didn’t cause a recession.

Neither did any of the other numerous financial crises that the Fed historically causes when they start hiking rates.

For example, we had the savings and loan crisis in the 1980s, which didn’t actually cause a recession. We had the Mexican default crisis of 1994. And Orange County went bankrupt in 1994 because the Fed was hiking rates at that time as well.

Let’s not forget the Asian currency crisis of 1997, the Russian default crisis of 1998, and the long term capital management crisis of 1998.

Remember, none of these actually caused a recession. And in fact, they didn’t stop the stock market from having one of the best decades in history. In fact, it was the second best decade behind the 1950s.

The point is, a financial crisis is far more common than you might think.

But every financial crisis, is not a great financial crisis as seen in 2008 and 2009.

But, doomsday prophets like Robert Kiyosaki and Nouriel Roubini will always spin a plausible sounding reason why the next crisis will be the next Great Recession. But we have to remember there’s a reason we call it the great financial crisis – because it was the worst economic catastrophe in 70 years.

Right now, there is a cause for concern in the commercial real estate sector. There are about $3 trillion in the commercial real estate sector.

Mortgages are outstanding at the moment. 50% of them are maturing in the next two years.

You may have seen some headlines about Morgan Stanley (MS) saying that there could be a 40% crash in commercial real estate prices worse than the Great Recession.

Well, it’s important to remember that this is their worst-case scenario, not their base case. The worst case scenario involves the Fed hiking to 5% and then keeping it there until the end of 2025.

I don’t believe that’s going to happen. The Fed says they plan to cut three times next year and be at 3% by the end of 2025, 2% lower than where we are now.

Now, it is true that 25% of these mortgages are maturing by the end of this year when the Fed plans to keep rates at 5%. So there will be some defaults, and there will be some loan losses.

But remember that there is an ocean of private equity money just waiting to scoop up distressed real estate at attractive valuations. That’s why the 40% decline is the worst-case scenario, not what’s actually likely to happen.

Now, 67% of commercial real estate loans are held by regional banks so there will be some defaults and losses, but those losses are likely to be far milder than the scary headlines make you believe.

The same is true of the coming recession. The FactSet economists’ consensus right now says there won’t be a recession, just 0% growth in Q2, -0.5% in Q3.

Then positive 0.2% Q4, 0.9% overall growth this year, 1.2% growth next year, and 2% in 2025.

But historically, economists are very bad at estimating recessions. They always underestimate how bad the contraction will be.

So likely a recession is coming, but nothing like the Great Recession.

And here’s why… States are flush with cash due to pandemic stimulus.

Corporations are sitting on $7 trillion in cash. Cities have also never been in a better position to handle a recession.

The world is still awash in cash.

For example, the lowest income earners right now are seeing wage growth as strong as 15.2% for leisure and hospitality.

And that’s the strongest part of the job market.

The middle class has been hit hard by inflation, but according to Bank of America (BAC), their excess savings won’t run out until the end of 2024.

And the upper class is expected not run out of excess savings until the end of 2026. Why?

Because according to the Federal Reserve, compared to pre-pandemic trends, Americans still have $4 trillion in excess savings.

Corporations have 7 trillion in cash. And states and cities have never had larger rainy-day funds. We have never been more prepared for a recession or anticipated one more than we are now.

And remember, the Fed plans to start cutting by no later than September of 2024 and probably much earlier.

Also, the economy itself is probably not going to need that much stimulus because this is nothing like the pandemic or the Great Recession.

So what does that mean for the stock market? Well, right now, stocks are trading at about 18x forward earnings or about 20x, if you factor in the historical average of 13% earnings decline in recessions.

But remember, this is going to be a mild recession with high inflation. So earnings might not decline at all.

Either way, though, a 15 to 30% decline in the S&P is likely on its way in the coming months, which would be around a 36% peak decline from record highs.

Basically, a historically average recessionary bear market. But of course, it’s not going to feel average.

Bear markets never do. The historical market bottom will likely be around September or October near the debt ceiling crisis.

And of course, we’ll talk about all of this more in future weekly updates.

But the point is, stocks will fall 15 to 30% within a few months. It’s going to feel like the end of the world.

Doomsday prophets will be out in force telling you how the market still has 50% more to fall. How banks are going to implode. Unemployment’s going to soar, and you should sell everything and buy Bitcoin and gold, just as Robert Kiyosaki has been telling you to do for ten years.

Now, let me assure you, these people are cranks and full of it.

Here’s how I know.

I track America’s financial stress every week by the Saint Louis and Chicago Fed’s financial stress indicators.

They include a 123 metrics updated weekly. We’re talking yield curves, credit spreads, loan rates, loan default rates on every kind of lending. If there is a crisis coming, it will show up in the data.

Now, after the March, banking crisis, there was a sharp spike in financial stress to historically average recessionary levels. And in the last two weeks, it’s fallen back down to below average levels compared to 1993 and 1971.

Again, if a crisis is coming, I will see it. And rest assured, I will tell you in these weekly updates.

Now, what does all this mean for Fortress Portfolio?

Now, a mild recession likely means slight earnings contractions for some of our financial investments, such as Toronto-Dominion (TD) and possibly Allianz (ALIZY).

But these declines will be nothing like the Great Recession.

And these dividends are 98% likely to be safe.

How do we know?

That’s thanks to our 3000 point safety and quality model based on over 1000 metrics, with data from FactSet rating agencies, hundreds of analysts and the bond market.

Now, let me give you a perfect example of why you should be excited about this recession and the kind of opportunities that are already here.

I’ll use next week’s recommendation, U.S. Bancorp (USB), as an example.

This is the fifth largest bank in America, and they do everything other than investment banking. USB is A+ rated with a 0.6% risk of failure, according to S&P.

Right now, USB’s yield is about 5.5% — a very safe yield.

And right now, you can buy USB at a 45% historical discount to fair value, trading at 7x earnings. That’s priced for -3% growth.

But guess what?

USB is growing 13% faster than any other large U.S. bank.

Now, for context USB has a 0.6% risk of failure, according to S&P, is one fourth the risk of nuclear war with Russia according to Goldman Sachs (GS).

Basically, if USB fails, the world has ended. The living will envy the dead and money will be the least of your problems.

How confident am I in USB?

Well, you can never be 100% sure because data can always change, even if all the data says this is a table pounding buy.

Also referred to as the 80% Howard Marks – John Templeton Certainty Limit.

But basically, that means I’ll die on this hill of confidence.

And that is how confident I am that USB is a classic buffet style fat pitch with 140% upside to fair value that could quadruple in five years.

Now, that’s all nice and good, but what about USB’s exposure to the banking crisis?

What about all those commercial real estate loans coming due?

Well, 14% of USB’s loans are commercial real estate. And right now, it’s loan loss reserve (meaning how much is set aside for losses) is 1.9% of its portfolio. Of that 1.9%, 2.4% is allocated for commercial real estate.

What are its actual losses right now?

Well, at the end of last year according to the reported earnings on the 19th of April, they were 0.23%.

Now, the payout ratio for the dividend is 40%.

And for the payout ratio to go over 100% and the dividend to be at risk, they would need to see earnings decline 60%. And for context, they fell 26% in the pandemic.

In other words, unless there’s a great recession level crash, that dividend is safe. Just as it was in the pandemic.

Now, for that kind of crash to happen, USB’s loan losses on real estate would have to be over 8.2%, more than triple what USB’s already planned for. And right now, it’s at just a fraction of what it’s planned for.

In fact, USB’s overall loan losses would have to soar by 725% just to hit the loan loss reserves it’s already planned for.

And guess what banks do when recession is coming? They add to those loan loss reserves, as we’re likely to see in the coming quarters with USB.

USB is one of the most conservative, high quality and best managed banks in the world.

And remember, USB hopes for the best and plans for the apocalypse.

And that’s why it’s my favorite U.S. bank and such a table pounding buy… Because right now it’s trading at 7x earnings.

Guess what?

The last time it traded at 7x earnings was during the COVID-19 pandemic. The only other time it’s been cheaper was at the depths of the Great Recession when the economy was on fire. At that time USB traded at 6x earnings.

That’s a 15% decline away.

Now, remember, we used 30% stops for our risk management.

And I’m highly confident it’s not going to fall anywhere close to that because that would require the P/E (price-to-earnings) ratio to be 4.9 with a 6.5% yield. USB’s 5.5% yield right now is already the highest it’s been since 1991, excluding the Great Recession.

In other words, USB is priced for a doomsday that is not going to happen, and which the current data says is 80% likely never to arrive at all.

This is the kind of safety and opportunity that FortressPortfolio offers you.

When the world is in chaos and the world’s best banks are trading like meme stocks, we show you the best opportunities to earn profit-like returns from blue-chip bargains hiding in plain sight.

Next week the latest issue of the Fortress Portfolio will be published with all the information you need to add USB to your portfolio.

So get ready…

I hope you enjoyed this weekly update and will join us next week when we talk about the downside risk scenarios for the coming recession.

And of course, please send us your comments and questions, so I can respond to them in these videos and in our monthly issues.

Just remember, I can’t provide personal financial advice.

Wishing you safe investing and a healthy and relaxing week.

This is Adam Galas signing off.