Weekend Edition: Get Ready for the Greatest Financial Mania the World Has Ever Seen

Editor's note: Today and tomorrow, we're sharing an important idea from our longtime friend and founder of Stansberry Research, Porter Stansberry.

You see, right now, we're seeing unprecedented warning signs in credit markets all around the world...

The global scale of these problems means the coming crisis—what Porter has called "the greatest legal transfer of wealth in history"—will be truly historic. And folks who don't see what's coming could be wiped out.

In short, he says this is a critical moment for self-directed investors. And we want to make certain you’re prepared…

Below is Part 1 of Porter's essay on this topic that was originally published on September 9, 2016, in The Stansberry Digest.

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It’s something you don’t see very often. It can lead to the most incredible gains of your investing life.

Or it can destroy all of your wealth if you’re swept up in it.

I’ve only seen two bona fide investment manias. I’m not talking about bubbles… or just overvalued securities. I’m talking about real "one way" trades – situations that can only lead to disaster. Yet for some reason, everyone comes to see the trade as a sure way to make money, not lose it.

Let me introduce the idea with a true story. It’s about John Templeton.

You might have heard of him before. He was very active in the markets for more than 50 years – between the Great Depression and the early 1990s. He built a huge mutual-fund company, Templeton Investments, which he sold in 1992 and made $440 million.

His first "big trade" came right after Hitler invaded Poland in 1939. Stocks sold off, hard.

There were 104 different stocks on the New York Stock Exchange that were trading for $1 or less. He put $100 into each of them.

His rationale was that during the Depression there was a surplus of everything, and therefore no profits. During a war, which was surely coming, there would be a shortage of everything and big profits. Within three years he’d made a profit on all but four of the stocks. Over a decade, the profits on this trade were more than 10,000%.

But that’s not the Templeton "big trade" that I want to discuss…

The first real financial mania I saw was in late 1999 and early 2000. Technology stocks had been on a tear higher since the mid-2000s, with companies like Intel, Microsoft, Yahoo, and Qualcomm earning huge returns for investors. Later, though, the number and quality of the companies reaching the public markets began to decline substantially. And by January of 2000, the situation reached a peak.

Garbage was being sold in IPOs to investors desperate to buy them. And so, en masse, investors began to believe a lie that couldn’t possibly be true.

It was the greatest financial mania the world had seen since John Law’s South Sea Bubble in the early 1700s.

I’m happy to report that we did a good job warning people about what was really happening.

As Steve Sjuggerud wrote in January 2000 (on the newsletter’s front page):

We are at the peak of most likely the greatest financial mania that will ever be seen in our lifetimes… and quite possibly the greatest ever witnessed.

With this warning, trailing stop losses, and basic securities analysis, we were able to avoid virtually all of the big losses during 2000 and 2001.

If you were in the markets back then, you surely remember a few of the most famous disasters – Pets.com, Webvan, and WorldCom. These firms were backed by respected venture capitalists and had business plans that were at least plausible. But this wasn’t just a bubble. It was a mania. Even the most obviously worthless ventures reached multibillion-dollar valuations.

Inktomi, for example, reached a $25 billion valuation in March 2000. It made generic software for internet service providers but never made a profit. In 2002, Yahoo purchased the company for $235 million. It overpaid. In 2009, the Inktomi software was donated to the public under an open-source license. Everyone can use it today for free.

Boo.com spent $188 million of investors’ money and was worth more than $1 billion (on paper).

It owned a single high-fashion online store and generated less than $10 million in revenue before going bankrupt in less than 12 months.

Pixelon was a digital-streaming company that launched operations with a $16 million party, featuring The Who and the Dixie Chicks. It failed in less than a year. It never produced any revenue.

And Lycos was a fourth-rate search engine. Spanish telecom operator Telefonica bought it for $12.5 billion. In 2004, it sold it for $95 million. It’s still around, believe it or not. Its owners promise that a "new Lycos" is coming soon. It’s traded in India, if you’re interested.

There were hundreds of IPOs like these. An index of dot-com companies tracked by TheStreet.com fell 75% in 2000. Many stocks fell by 99% – including U.S. Interactive, Pacific Gateway Exchange, Cornerstone Internet Solutions, and Worldwide Exceed Group.

We read the prospectuses of many of these IPOs and laughed about how anyone would buy them at any price. Most of the disclosures said clearly that these companies had few, if any, clients. Most of them said they had no written agreements or contracts.

The risk disclosures explained, in plain English, that these weren’t real businesses and they had close to zero chance of staying in business. And it didn’t matter. No matter what was disclosed, investors would buy the stock. It was a true mania.

Templeton watched the market action quietly from his retirement home in the Bahamas.

Finally, on January 1, he knew that the mania couldn’t go on much longer. The frauds were outnumbering the legitimate IPOs by 10 to 1. He called his broker in New York and gave very simple instructions:

Short as many shares as you can get of every technology IPO that lists. Establish the position 11 trading days before the lock-up expires. (The lock-up prevents insiders from selling shares until some period after the IPO, typically 90 days.)

In the first half of 2000, Templeton ended up shorting 84 stocks, putting an average of $2.2 million into each of them. He made more than $100 million on the trade in about a year. More than half of the stocks fell 95% or more. Of the trade, Templeton told Forbes magazine:

This is the only time in my 88 years when I saw technology stocks go to 100 times earnings; or, when there were no earnings, 20 times sales. It was insane, and I took advantage of the temporary insanity.

I never thought I’d see a mania like that happen again in my life.

Remember… this wasn’t merely a case of overvalued stocks. This was a situation where investors were completely ignoring the obvious fact that the overwhelming majority of these companies would fail and then bidding them up to completely insane prices.

This wasn’t overexuberance. It was madness. And over the next 24 months, investors saw $5 trillion of market value disappear.

But today, there’s a much, much larger and more dangerous mania. It’s a mania that has been created (and is being sustained) by central banks and printing presses.

Good investing,

Porter Stansberry

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