Puerto Rico bond bashing plus today’s stock trading inaction

Puerto Rico's Capitol. (Via Wikipedia)
Puerto Rico's Capitol. (Via Wikipedia)

WASHINGTON, July 2, 2014 – As we indicated in our earlier holiday report, light trading and heavy international and political news will make trading treacherous for the rest of this holiday-shortened market week.

As for us, we’ll likely remain on the sidelines for the rest of the week unless we have to defend defensive positions we’ve taken in gold and silver ETFs, including SGOL, SIVR and the double-long silver ETF, AGQ.

We are trying to remain relatively protected by these classic defensive positions over the long weekend due to the recent military action in the Ukraine and the unsettling child murder situation in Israel and Palestine, both of which could provoke unpredictable action on either side in both conflicts—action that could badly damage markets while traders are unable to trade.

Light trading action has not been friendly to either of our pair of IPOs this week, either. Service Master (SERV) MIK took a bad hit in yesterday’s trading after hovering around its $17 offering price. Today’s mediocre action continues, with MIK now down around $16.75, over 1% to the bad. Both issues were chancy, as both are overly levered partial escapees from the vulture capitalist nest. But time will tell, as this week’s short and light trading is not exactly helping these new issues out.

On the fixed income front, we’re also watching with some concern the recent downgrade of Puerto Rican public corporation debt−such as utility (PREPA) bonds−by Moody’s. S&P denounced Moody’s downgrading of these bonds to junk status, but also has the same bonds on negative credit watch themselves, an action inspired by the Commonwealth’s recent legislation allowing a wider range of action to deal with the essential insolvency of these entities. In other words, dreaded actions like default or restructuring, either or both of which could end up giving investors in these bonds a severe haircut.

We hold a small amount of short-term Puerto Rican Government Development Bank (GDB) bonds, which, like the utilities, took a hit after yesterday’s downgrade. But we are modestly reassured by the fact that Moody’s included neither the government of Puerto Rico nor the GDB in its downgrade, likely due to the fact that, at least on a functional basis, both government entities are the same.

Our GDB bonds are not insured, however, so things remain dicey. But we’d rather not sell at a modest loss at this point since our GDB bonds mature in December. Touch and go here.

The Puerto Rico situation, if it’s allowed to spin out of control, could be a major bond and stock market disaster as it’s not only the Maven who holds Puerto Rican bonds. Given the fact that they’re both Federal and state income tax exempt in ALL states (at least the last time we looked), Puerto Rican (and also U.S. Virgin Island) bonds have been popular with investors and funds alike, particularly in high-yield funds and ETFs which can easily juice their advertised yields by including a nice chunk of these vehicles in their portfolios.

Although Puerto Rican bonds are not, in fact, backed by the full faith and credit of the U.S. Government; and although Puerto Rico, since it’s not a sovereign government, can’t declare bankruptcy for itself or any of its governmental or quasi-governmental entities, we have to imagine that in the event of an unfolding fiscal catastrophe on that former island paradise, the Feds would be prompted to do something to stave off what might be a market-toppling domino effect on all municipal bonds—at least short term—should Puerto Rican bonds undergo a serial collapse.

But given the current Administration, one can never tell. While Puerto Rico is nominally represented by a non-voting Congressional Representative, and while its residents, as U.S. citizens, can vote for President, the Obama Administration likely sees little if any political advantage in supporting the island’s financing as such taxpayer support wouldn’t lead to material political gain which is the only thing that floats Obama’s boat.

In other words, we’ll wait and see for now. Puerto Rico’s government and its almost synonymous GDB will be the last to go if the dominoes fall. But, like poor Cinna the Poet in Shakespeare’s “Julius Caesar,” these bonds, too, could get destroyed anyway by any economic cataclysm since they, like the failing entities, all boast Puerto Rico’s name emblazoned on the bond indenture.

In other news, we’re also watching our carefully cultivated flock of REITs and preferred stocks, all of which are as interest rate sensitive as municipal and private sector bonds. Like most investors these days, in the absence of good yields on (supposedly) safe Federal government bonds and bank CDs, we have been going for yield to a greater degree than is generally healthy and could get burned if the market decides to wake up and actually notice that the Fed’s QE3 bond-buying spree has wound down from its earlier $65 billion a month rate to a scheduled $15 billion in July. This puts QE3 in extinction mode, circa September.

True, the Fed has decided to keep interest rates near zero for the foreseeable future, but at least some Fed governors are now foreseeing interest rate boosts as early as March 15, 2015. Since the market has a habit of discounting events roughly 6 months in advance, September could finally be the month this bull market breaks, particularly if inflation remains as nasty as it appeared to be last quarter.

So it’s watchful waiting for the rest of this week. Stay tuned, stay safe, and enjoy the holiday weekend and a welcome break from the Wall Street inaction.

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Terry Ponick
Biographical Note: Dateline Award-winning music and theater critic for The Connection Newspapers and the Reston-Fairfax Times, Terry was the music critic for the Washington Times print edition (1994-2010) and online Communities (2010-2014). Since 2014, he has been the Business and Entertainment Editor for Communities Digital News (CDN). A former stockbroker and a writer and editor with many interests, he served as editor under contract from the White House Office of Science and Technology Policy (OSTP) and continues to write on science and business topics. He is a graduate of Georgetown University (BA, MA) and the University of South Carolina where he was awarded a Ph.D. in English and American Literature and co-founded one of the earliest Writing Labs in the country. Twitter: @terryp17