Saturday, August 22, 2015

Four Things: What Investors Shouldn’t Do Now

By Jason Zweig, Wall Street Journal, Aug. 21, 2015

Stocks slumped world-wide this week, with U.S. and European markets off more than 5% and the Shanghai Composite Index losing more than 11%. Oil prices also skidded, dropping more than 6%.

Traders feared that slowing growth in China, the devaluation of the Chinese currency and the overhang of too much debt could stifle global economic recovery.

Here are four things you should know about how not to react.

Don’t fixate on the news.

The more often you update yourself on the market’s fluctuations, the more volatile and risky it will appear to you—even though short, sharp declines of 5% to 25% are common.

The U.S. stock market has, in the past few years, been extraordinarily placid by historical standards. Even the sudden drops of the past few days are well within the long-term norm.

Fixating on fluctuations in the short term will make it harder for you to remain focused on your long-term investing goals.

Don’t panic.

While stocks are certainly not cheap, they aren’t wildly overpriced, given today’s levels of interest rates and inflation. U.S. stocks are trading at 24.9 times the average of their long-term, inflation-adjusted earnings, according to data from Yale University economist Robert Shiller—down from 27 in February.

Over the full sweep of bull and bear markets in the past 30 years, they have traded at an average of 23.8 times adjusted earnings.

Don’t get hung up on the talk of a “correction.”

A correction is typically defined as a decline in price of 10% on a widely followed index such as the S&P 500 or Dow Jones Industrial Average.

The term doesn’t have official status, however: Until fairly recently, declines of 5% and even 15% or 20% were often called “corrections.” A market decline of 10% has no real significance in and of itself.

What matters is the outlook for the future; that doesn’t depend on whether the market is down about 10.2% rather than 9.8%.

Don’t think you—or anyone else—knows what will happen next.

After a market drop, or at any other time, no one knows what the market will do next.

The one thing you can be fairly sure of is that the louder and more forcefully a market pundit voices his certainty about what is going to happen next, the more likely it is that he will turn out to be wrong.

Stocks could drop another 10% from here, or another 25% or 50%; they could stay flat; or they could go right back up again.

Diversification, patience and, above all, self-knowledge are your best weapons against this irreducible uncertainty.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Tuesday, August 11, 2015

Update on Municipal Bonds

By Rodney Johnson, Senior Editor, Economy & Markets

Municipal Bonds.  This boring corner of the investment arena generally has all the excitement of a pet rock circus, but recently that’s changed. The new worries in the muni market might be troubling for some, but they give the rest of us a chance to snag assets on the cheap.

The long-term default rate in municipal bonds is a fraction of one percent. Only 0.17% of the bonds in the S&P Municipal Bond Index defaulted in 2014. This followed an even lower rate of 0.11% in 2013.

Based on this information, the risk of default appears exceptionally low. But the historical numbers don’t tell the whole story. There are two big caveats.

A spectacular default in one city can cloud the entire market. Besides that, municipalities have new challenges that they have not faced before.

As for big defaults in the news, Detroit comes to mind. I’ve written before that its bondholders were treated worse in the bankruptcy than the letter of the law allowed. They brought home pennies on the dollar, while other creditors that were subordinate were made whole.

This is a recurring theme across the country, so it’s no surprise, but it still serves as a warning to all municipal bond investors.

General obligation bonds state that the payments to bondholders are backed by the full faith and credit of the issuer, but in times of crisis, issuers don’t hold up their end of the bargain.

Bond buyers are forced to accept less than they’re owed, and so far haven’t prevailed when they challenged these outcomes. Creditors of cities like Pritchard, Alabama, Central Falls, Rhode Island, and Stockton, California have all suffered similar fates.

A large bankruptcy on the horizon is Puerto Rico. In fact, it defaulted on its bonds last Monday. The U.S. territory can’t pay its bills, so now it’s calling on all “stakeholders” to negotiate in “good faith.”

In other words, they want bondholders to agree upfront to cut the face value of what the territory owes them. This is despite the fact that many of those bondholders own general obligation bonds – which, again, are backed by the full faith and credit of the territory.

Territory officials are putting investors on notice that even though their constitution states debts must be paid before all other creditors, the government won’t cut any operational expenses (salaries, services, etc.) in order to make good on their principal and interest payments.

Adding to the uncertainty unleashed by the proceedings in recent municipal bankruptcies and the developments in Puerto Rico are the ballooning costs of pensions and health care benefits that cities and states around the country are facing.

While unfunded pension liabilities are old news, the accounting board governing these entities only recently required that unfunded health care liabilities be included in city and state calculations of financial health.

The results are ugly. In addition to a trillion-dollar unfunded pension problem, it’s now clear that municipalities in the U.S. also have a trillion-dollar unfunded healthcare problem.

As these figures make it onto the financial statements, the fact that many cities and even a few states are bankrupt on paper will start to sink in with ratings companies, analysts, and investors.

While none of this is good news, it can have a good outcome.

The combination of high-profile bankruptcies, bondholder treatment in bankruptcy proceedings, the direction of negotiations in Puerto Rico, and the sudden addition of a trillion dollars in liabilities to books should produce enough uncertainty and concern in the municipal market to drive prices down and yields higher.

The negative news cycle could even cast a pall over all municipal bonds, giving investors a chance to pick up high quality names on the cheap.

This is where work and patience pay off.

The key to buying municipal bonds is the same as purchasing any other investment. Do your homework. The old way of buying bonds – look at the rating and pull the trigger – is dead. Anyone who trusts a rating deserves the outcome, whatever it is.

Instead, investors can and should review the finances of bond issuers and determine for themselves how likely it is the city or state will make good on its debts. I know the overwhelming majority of them will, but not all.

Once investors have found and purchased bonds issued by solid municipalities, then they must be patient. The negative news over municipal bonds won’t go away anytime soon.

This particular market will likely be roiled by turmoil as the problems in cities and states in tough financial positions, like Chicago and Illinois, come to the surface. But as long as investors did their homework and hold solid bonds, they won’t have to worry.

Their principal and interest will keep landing in their mailbox. And the best part is, they still won’t have to send any of it to the taxman.

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The D2 Capital Management Tax Free Income Portfolio is currently yielding 4.472% (Trailing 12 month Tax Equivalent Yield at 28% Tax Bracket, as of 10 August  2015). 

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.