Monday, November 11, 2013

Mark's Stock Report 11-2-13


Before 1970 the economy Puerto Rico, an American territory, had impressive growth and compared favorably with the upstart Asian tiger economies. As part of the United States, Puerto Rico had the advantages of being part of the American legal system which strengthened private property rights, contracts, patents, and free speech.This arrangement with the United States aided Puerto Rico to attract outside capital, generate investments, and opened up trade.Puerto Ricans could travel freely to the United States to acquire working skills, attend higher education, and arrange connections with American firms.The United States was generous and aided Puerto Rico with paid infrastructure and improved education.

After 1970 Puerto Rico became more engaged in the American entitlement system and the country has gone downhill since then.According to an older 2006 article of 'The Economist' GDP per person as a percentage of the US has fallen every year since its peak in 1970.Federal transfer payments rose sharply in the 1970's where those transfers make up more than 20% of the island's personal income.For example, Puerto Ricans are eligible for federal disability payments which is a great deal of money given Puerto Rico living standards.Instead of a promising economic future, one in six working-aged men don't work and claim disability benefits.For Puerto Ricans, this has become a way of life not a helping hand up.Federal disability transfer payments pay more than the market wage in the country.Though residential areas may be shabby, satellite dishes adorn most rooftops - a result of easy money.One other change since 1970 occurred.As US largesse in Puerto Rico rose, the government of Puerto Rico expanded adding to a growing welfare state and promoting increased regulations.Some 30% of Puerto Rico's jobs are in the government sector.Puerto Ricans either want to work for the government or live off transfer payments.Ambition is not a going concern.Understandably, the economy and government finances of Puerto Rico are currently a disaster.

Per Morningstar (10/17) the Puerto Rican economy deteriorated further during 2006 with the expiration of a tax benefit that caused manufacturers on the island to leave.And, since that time, Puerto Rico has suffered with increased crime, inferior infrastructure, and a contracting economy.Fast forward to May 2013, Puerto Rico's economy creaked under financial strains sending its bond rates to an average 6.8% yield by last September.Puerto Rico, who relies heavily on US funding, was hit again during the US government shutdown.From last May to Oct 2013, the Barclay's Puerto Rico Index fell 18.7% as compared to their more general Municipal Bond Index falling by 4.4%.It has become obvious to many that Puerto Rico 'sovereign' debt is in danger.The NY Times reported the Puerto Rican national debt was $87 billion (including pensions) or $23,000 per capita and that the island has been 'effectively shut out' of the bond markets.The WSJ reported that a senior Obama official claimed that the White House is working with federal agencies 'to make sure that federal resources are fully utilized for maximum impact for the people of Puerto Rico'.Last March Fitch Ratings on $10.6 billion of Puerto Rican debt was lowered to BBB- or almost to a junk status.According to Fitch, Puerto Rico has an estimated $490 million shortfall.Puerto Rico may be entering into the dim area of not being able to pay on its debt though it cannot legally default.Puerto Rico is ineligible for Chapter 9 municipal bankruptcy as their debt is treated as a foreign obligation.

Puerto Rico isn't a case where the territory is hitting some financial speed bumps; instead its economy would be in a Greek-like financial death spiral if were not for the arrival of $1.9 billion in Fed stimulus money between now and the end of the year per Miguel Romero, Secretary of Labor and Human Resources.Though this stimulus money is meant for infrastructure I have a feeling it is really meant to keep Puerto Rico finances barely above water giving time for a solution to be sought.Similar to Greece, Puerto Rico is becoming more like a financial black hole where in-time stimulus money is probably more like a temporary bailout but corrects no problems.Those problems center upon an expanded government and entitlement benefits they could not afford which, in turn, caused a migration out of the country of its best and ambitious leaving behind, in general, those satisfied to watch cable TV and receiving checks of free money.The unemployment rate in Puerto Rico stands at 16.5% which if it were a US state it would be the worst off financially of all them.Despite its high unemployment, the Puerto Rican government has been finally forced to and intends upon laying-off up to 30,000 public workers per the Latin American Herald Tribune (10/28/13).Over the past year 9,400 jobs were lost in manufacturing, 11,000 in construction, 10,500 in retailing, 5,200 in services, and 4,400 jobs lost in finance for a declining population of 3.7 million (4.9 million live in the continental US).Per a recent article in Reuters, Puerto Rico's problems extend into increased crime (murder rate is six times that of the US), decaying infrastructure, drug violence, falling GNP, and swaths of vacant condominiums and offices.Though the word is rarely used, this is a 'depression'-type economy.Puerto Rico's economy has contracted 14% since 2006. Move over Detroit, Puerto Rico is six to eight times your demise should they default by simply not paying the interest on their debt.As of October 9th, some Puerto Rico bond yields have shot up to 10% due to increased risks.

When Puerto Rico wanted to borrow, Wall Street was more than happy to help but that help was lacking any needed advice of fiscal rectitude (not required when lending to a sovereign - but still).Since 2006 Puerto Rico sold $61 billion of bonds in 87 deals where Wall Street firms pulled in $1.4 billion in fees per the WSJ.Attempting to smooth over investor fears, Puerto Rico officials make trips to New York where holders of Puerto Rican bonds are seeing their investments turn downward.The money received from all this debt did not go to productive uses for the most part but was used to bridge budgetary shortfalls.Now, the territory is in trouble and close to default attracting both the lawyers and the regulators.The 'Government Development Bank' oversees Puerto Rico's bond deals and one must wonder where they were as they oversaw little.Puerto Rico's fiscal problems are unique and somewhat more dangerous in one sense:Puerto Ricans do not pay federal taxes which means their residents are not held liable for their government's debt per an official of the Government Development Bank.As aside:what makes anyone think that American citizens are going to joyously back-stop American government debt?

So, who cares if Puerto Rico is in a financial crisis?The US market is driving to new highs.This is but the result of a market that can only 'see' through the window of unending flow of stimulus money.There is $52 billion of tax-supported bonds from Puerto Rico held by large US investors who care.The attraction of these bonds is the unusual circumstance that investors are exempt from both federal and state taxes.The problem is that if Puerto Rican bonds become labeled as a non-investment grade (it is surprising to me they remain investment grade) instruments, large investors such as mutual funds may have to sell them off at losses driving bond prices ever lower and, worst, these bonds could not be margined or borrowed against which could set off a flurry of margin calls.Even so, falling Puerto Rico bond prices are making themselves felt as they are so widely held.Going back to Morningstar, the largest 25 funds having 5% or more of their holdings in Puerto Rico muni bonds have all produced lower returns from last May to Oct. 1 save one exception.Rochester Fund Municipals have almost 25% of their holdings in Puerto Rico bonds and their return in the past four months is a -12.22%.Oppenheimer Rochester AMT-Free NY Muni has 19% of their portfolio in Puerto Rico bonds and has returned a -11.33% in the same time period.In the bond world this is considered carnage.A fund, regardless of size, with the largest exposure to Puerto Rican bonds the returns for the past four months is somewhat dire.The Franklin Double Tax Free Income Fund is the worst with a weighting of over 61% of its holdings in Puerto Rican bonds is down -15.67% in the past four months; Oppenheimer Rochester VA Municipal Fund down 14.12%; Forward Credit Analysis down 13.69%; and so on.This is most likely just the beginning as Puerto Rico walks down the path of forced austerity.

American Cities:In line with this blog's more common themes, Puerto Rico is not just a one-time event though its financial problems have been building for decades.It is a part of more underlying trends happening across America where is not just a coincidence that many cities and municipalities in the US are struggling with financial issues at the present time.The more basic of these underlying themes is the growth of government at the expense of the private sector, growth of entitlements that cannot be sustained, and the growth of debt influenced by misleading indicators manufactured by the Federal Reserve where that debt was encouraged by Keynesian nitwits and large financial firms willing to 'aid' them sell their debt without warnings of fiscal limits.And from an accumulation of these underlying trends spring the offshoot problems of decaying infrastructure, crime, increased drug use, underfunded pensions, weaker tax bases leading to lower revenues, and corruption to name a few.This is a crude description of Detroit and of the events compounding its bankruptcy where, to some, that the event of a Stockton, a Puerto Rico, the growing struggle of a Chicago,a Jefferson County, or a Boise County all happen in roughly the same time period but for some reason are not connected.According to Governing, a website that tracks municipal bankruptcies, that 38 municipal bankruptcy filings have taken place since 2010.Though this may seem it is few in number it is an area where bankruptcy is often prohibited or restricted.Cities in trouble often are 'hidden from view' as they go into receivership or are supported by their states.

The growing problem of many American cities was recently recognized by the Wall Street Journal where they are currently publishing a series of articles which describes the financial problems some American cities are now facing.This series of articles is based upon research and data gathering from government sources, the Rockefeller Institute, and Merritt Research Services who reviewed 250 cities.I offer some factoids from that series of articles.

1) Cities with the lowest per capita value in taxable real estate in 2012 where the 250 city median is $79,840:Buffalo $26,316, Detroit $26,727, Rochester (NY) $28,505, Philadelphia $28,586, and Allentown (PA) $28,621.These are some of the worst cities and indicate a weak real estate market and it questions a city's ability to raise additional revenue.

2)Pension costs with the 250 city median of 10% meaning 10% of the city's general fund was spent on pension costs in 2012:Torrance (CA) 24.6%, Springville (IL) 24.8%, Hollywood (FL) 25.1%, Roseville (CA) 25.3%, and Pasadena, San Jose, Oakland, Berkley, and Anaheim all in California ranging from 43% down to 25.4%.Pasadena is the worst.A city paying over 20% of its funds on pensions is a financial backbreaker.

3)US cities with the least number of days of cash available in their main operating fund in 2012.The 250 city median is 81.1 days:Pomona (CA) 0, Charleston 0, Fresno .1, Independence (MO) .9, New Orleans 2.5, Springville (IL) 3.1, Topeka (KS) 7.3, Allentown (PA) 7.3, Chicago 8.7, and Shreveport (LA) 10.3.These are large US cities that have problems paying their bills.

Puerto Rico's financial woes are not just a one-time isolated event but is part of a widespread problem across America.Much of it comes down to benefits, entitlements, and being part of an actual depressed economy with a shrinking revenue base.In the end it is debt, debt, and more debt.


During the past wrangling over debt and spending issues between the Republicans and the Democrats a grand bargain was always sought but was never obtained by Obama.For coming fights over the debt ceiling and government spending it is highly likely a grand bargain will remain elusive.The primary reason for this situation are the extreme economic policies (I use that word loosely) of the government and Federal Reserve which in turn have given rise to the Tea Party and the winning elections of a group of conservative Republicans in the last mid-election.The Obama reign of six years and of a liberal Federal Reserve brought about a number of extreme actions and results such as the highest US government debt in history, record deficit spending, the highest percentage of Americans on government hand-outs, massive money printing few understand, the government command of healthcare, and a soaring stock market hitting all-time highs amid declining (real) productivity.This has created a situation where two political groups completely opposite of each other, extreme liberals and those who are highly conservative, do the actual political battling leaving the moderates of both parties almost paralyzed if it was not for the fact moderate Democrats outnumber moderate Republicans when it comes time to vote.Both opposite poles almost have a check on each other.It is interesting if not with dismay that conservative Republicans who look to cut spending and may even advocate a balance budget are verbally hammered with labels of being radicals and extremists by the most liberal (extremely so) president in American history.These are battle lines where compromise (a grand bargain) is nearly impossible.The best they could do was to defer the fight until a later date rather than force the government into damaging spending cuts with suddenness rather than by more controlled measures that the conservatives wanted.

Interestingly, the Republicans did not cap the debt ceiling (raising it just enough for the government to get by financially) after the government shutdown ended leaving the Obama administration free to spend whatever it wanted for the next three months.In that sense Obama got his way and arrogantly declared victory.What is not well known by the public is that just after the end of shutdown, government deficit spending overnight shot up $327 billion putting the official US debt over $17 trillion.Somehow the US Treasury used $327 billion in emergency spending without raising the debt ceiling but after the shutdown ended that amount had been netted back out.In other words, the debt ceiling did not prevent the government from spending beyond it during the shutdown.This is telling me that any pain felt by the shutdown was contrived for political effect.

Though Obama may have declared victory this victory is a false concept and may have planted the seeds for conservative victories in the coming mid-election.Since Obamacare was a sticking point during the shutdown negotiations and soon after that the roll out of Obamacare was essentially a disaster we have what will become a politically wounded president.Any democrat running to keep his seat in the coming election will have to disavowal Obamacare (and therefore disavowal Obama).You can't support a massive program like Obamacare when they can't get it to work after three years of preparation. One should wonder why the complexities of the NSA spy network works so efficiently but Obamacare with full government support turns out to be a nightmare disliked by the majority.Politically, Obamacare is deadweight to any incumbent who remains in support of it.

The odds are gathering that the Tea Party conservative-type candidates may again show strength in the coming fiscal debates and in the coming mid-elections.Though the Republicans caved in during the shutdown, the conservative wing remained holding steady with their 'no' votes just as they had promised to do.The most liberal part of the Democratic Party made heroes out of the more obscure conservative congressmen as they were unable to break them as they did to the Republican moderates. New congressional leaders were born.It remains, extreme liberals and extreme conservatives have no room for compromise.I believe that the continuing failure of Obamacare not only makes conservatives a little bit stronger for the next go around but will also cause some defection among the Democratic ranks.A grand bargain is not likely.

As a thought of fancy, it would have been interesting to see what would have happened if no agreement was made during the shutdown though highly unlikely.The government would have been forced, supposedly, to spend only that money they received. We would have seen how dependent this country is on borrowed money - without deficit spending they just couldn't function.This blog really has one sole piece of information at this time to impart.That is stocks are at levels twice their actual value.Many of these blogs are spent explaining why this is so.In the mainstream media no one questions why a stock market can be elevated at historical heights at a time when the US economy is being slowly gutted where trillions is thrown at it only to generate meager (somewhat fabricated) GNP growth.The US now has more people receiving some kind of transfer payment than the number of those working. Wages are declining and one who receives disability has a higher standard of living than one who works for $10 or less an hour. We have no plan and we probably have no way out without financial pain given our current leadership.If the US government spent only what it took in, profits of many corporations (who rely on government contracts) would simply evaporate and promises of entitlements would take serious cuts.Sometimes I think I'm just a voice in the wind.

The stock market is seeing volumes at extreme lows.This should be noted as worry, however, low volume is not as much of a concern for a rising market but, in a falling market, it can be deadly as there will be gaps of too few buyers which can make for sharp declines out of the blue.This blog isn't conductive to financial advice but I'll make an exception.As I believe that long-term rates will (or eventually will) rise and that, in general, treasuries are on the side of the sell I have purchased shares of TBT which is an ETF which follows long-term treasury rates. I then sell short-term (one to two weeks) call options at strike prices around 1 to 1points above the current price of TBT.If my TBT is called away, I just buy them back and sell the call options again.Otherwise, I keep selling the options over and over again.This is an investment strategy to think about for a small part of your portfolio.It is not as risky as stocks or bonds and should give you a fair return without much heartburn or sleepless nights.

Be careful and take care.
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