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Welcome to the market! Even in my area of specialty, municipal bonds, we have the suffering of the Puerto Rican people as well as now, the suffering of Puerto Rican municipal bond investors.

Greece, China and Puerto Rico, Oh My!

July 22nd, 2015 by Kurt L. Smith
  • The mile markers continue to move on by. Kicking the can down the road appears to be running out of steam and now people are truly being hurt as real losses are now affecting millions of people.

    Trends change and this is the strongest message I want to convey to investors. We are living in a period of time in which long-term trends that have been in place for decades have changed and I believe we will see the largest and most significant trend change when stocks join the crowd.

    By far the biggest trend change has occurred regarding the cost of money. Interest rates are how we measure the cost of money and this trend changed in 2012. After thirty years of lower and lower interest rates, the low cost of money meant all assets were relatively worth more. As many financial models discount future cash flows at lower and lower rates, the value of these assets moved higher and higher.

    One notable laggard in the interest rate trend was the bellwether thirty year US Treasury bond. The cost of money has the greatest price effect on the longest maturing bonds. The lowest interest rate cost on long-term treasuries (ever) discounted for a long period (thirty years) results in the highest price for the bonds (ever). So while the trend for interest rates changed in 2012, investors pushed the bellwether to an all-time low interest rate on January 30, 2015, corresponding to its all-time high in price.

    But we live in an era of trend change, so the spike in price culminating on January 30th low in interest rates quickly evaporated. In a matter of several months, the price of the bellwether US Treasury Bond fell eighteen percent in price (late January through late June).

    We are at the end of the interest rate decline trend. This is hugely important for investors because most investments have to be sold in order for you to get your money back, let alone sold to realize a profit, generally one’s primary reason for investing.

    Selling your investments is hard. Very few people are able to do it; very few of those are able to do it profitably. Sometimes you cannot sell (see China), but other times you just tell yourself that you will sell if Gold gets back to $1500/ounce, or oil gets back to $75, or long-term bonds go back up. Good luck with that.

    No, the time to sell is at high prices while you can, not later when you either can’t or you don’t want to. In a world of trend change, holding out for the last dollar of profit in the bellwether bond might have proven worthwhile, but you were fighting the trend and your opportunity was fleeting.

    This is not the way investing used to be; this is unfortunately how investing is today. You cannot explain it but you better accept it and act upon it before the next leg of the trend change occurs.

    The reason the oil boom is over is because it has run its course (up) and the next move is down…for many years to come. If you were holding out for higher prices, I am sorry. Why did the market turn? You would be just as well served to make up a story because at the top everything looks rosy for years to come. Markets turn; that is what they do.

    I believe we have been blessed to have participated in one of the greatest trends ever: the trend of cheaper money (lower interest rates). The effect of this trend has been huge for the wealth of the world. Even the Federal Reserve (as well as other Central Banks of the world) became willing participants to buy assets (bonds) that appeared to move in only one direction (up). Those…days…are…over!

    It is easy to appear to be in control when the trend is going your way. Bill Clinton knew this and was a master at moving only in the direction of trend. The Fed is the same way. As the trends change, and in particular, the last trend, Stocks, we will begin to see just how out of control things will appear.

    Political leaders have yet to find the will to help Greece. Regardless of how you feel about the situation, millions of people are suffering. The Chinese stock market drops forty percent in one month and political leaders in China try something new each day to try and stem the losses. Welcome to the market! Even in my area of specialty, municipal bonds, we have the suffering of the Puerto Rican people as well as now, the suffering of Puerto Rican municipal bond investors. Again, millions of people are affected.

    We have always had crises. We tend to have crises at changes of trend. However we rarely experience a crisis when we have significant trend change and I say the end of a thirty year trend of lower interest rates qualifies as a significant trend change. This time is different!

    If you believe that we will always have access to more credit and are willing to continue to borrow to buy assets (namely bonds and stocks), then you have nothing to worry about. This trend change that I talk about could be erased if the cost of money goes down and the availability of credit continues unabated.

    I am calling it as I see it. With one trend change after another since commodity prices peaked in 2011, I believe the trend is my friend. I urge you to consider the implications for you and your family.

    Dayton Independent School District, TX

    Moody’s Aaa (Aa3 Underlying) S&P: AAA (A Underlying)

    Permanent School Fund Guaranteed

    Due 2/15 Dated 7/1/15 Maturity: 2/15/2045

    Sale Amount: $75,435,000

    YEAR MATURITY COUPON YTM*
    1 2016 2.00% 0.38%
    2 2017 2.00% 0.62%
    3 2018 4.00% 0.94%
    4 2019 3.00% 1.19%
    5 2020 2.25% 1.42%
    6 2021 5.00% 1.72%
    7 2022 5.00% 2.03%
    8 2023 5.00% 2.26%
    9 2024 5.00% 2.41%
    10 2025 5.00% 2.56%
    11 2026** 5.00% 2.70%
    12 2027** 4.00% 2.99%
    13 2028** 3.00% 3.24%
    14 2029** 3.125% 3.36%
    15 2030** 4.00% 3.44%
    16 2031** 4.00% 3.52%
    17 2032** 4.00% 3.57%
    18 2033** 4.00% 3.62%
    19 2034** 5.00% 3.26%
    20 2035** 5.00% 3.30%
    25 2040** 4.00% 4.04%
    30 2045** 4.00% 4.06%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2025

    Source: Bloomberg

    This is an example of a new issue priced the week of 7/20/15

    Prices, yields and availability subject to change

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