JUNE 2015 INVESTMENT JOURNAL: DEBT DEBACLE
- Supreme Court affirms Obamacare and same sex marriage
- Greece imposes capital controls and defaults on IMF payment
- Puerto Rico to seek debt restructuring
This month saw most major asset classes finish in the red after worries grew around debt issues in Greece and Puerto Rico. International equity markets fared worse than US stocks by 1%, but international developed stocks still lead other equity markets for 2015. Bonds also lost ground during the month, pushing most bond categories further into the red for the year. Gold was down 1.5% in June, but commodities more broadly gained ground, being the only positive performing asset class overall in June. Broad commodities have still been the worst asset class for investment over the last 3 and 5 year periods, so continued strength in coming months could indicate a long-term change in the downtrend that's been in place over the last 5 years.
The chart below highlights the flat to negative returns major asset classes have seen over the last twelve months. US stocks have been the leader over the last year and still continue to display the most strength as we enter the third quarter. Momentum has stalled in equity markets broadly in the first half of 2015, and we'll be watching closely to see if it weakens further as we enter the second half of 2015.
The U.S. Supreme Court handed down two major decisions in June. In the first ruling on June 25th, they decreed that health care subsidies as authorized by the Affordable Care Act are legal and available to all enrollees, regardless of whether enrollees obtained coverage through a state exchange or the federal HealthCare.gov. Hospital and some health care provider stocks rallied on the notion that their future revenue streams would be more secure. Investors continue to reward health care stocks in general, with year to date performance for the sector up 10%, versus a flat overall market.
The other ruling on same sex marriage has significant implications for tax, retirement, and estate planning nationwide. Same sex married couples will not need to file different federal and state tax returns, and will be able to claim spousal and survivor benefits under Social Security. Health care benefits will be expanded. The use of life insurance to fund estate taxes will decline as married same sex couples are afforded the unlimited marriage exclusion from estate taxes nationwide, plus the portability of the deceased spouse's unused exclusion amount (use of the unified credit). All in all, a lot of complex tools and strategies will be unwound, and will result in greater uniformity across the financial, legal, tax, and health care industries.
At month end, the Greek debt crisis forced its way back onto the main stage of the world economy. After a failed series of negotiations with the EU, ECB, and IMF (the Troika), the Greek Parliament voted June 28th to hold a referendum on July 7th for the Greek people to vote on whether to accept the latest bailout terms. (Never mind that the proposal was not final and had already been withdrawn by the Troika). Prime Minister Tspiras then announced in a nationally televised address later that day the imposition of (temporary) capital controls, including the closing of banks, a daily ATM withdrawal limit of 60 euros, and limits on cash transfers abroad. On Tuesday, June 30th, Greece confirmed that it was defaulting on a 1.2 billion euro payment to the IMF after the ECB withheld any further monetary assistance.
As we write this, the Troika has refused to negotiate any further until after the July 7 referendum. Stocks sold off initially, but regained their composure as the month closed. Investors globally are awaiting the next act of this long-running drama.
This is a good time to re-visit the "Greek Tragedy" that has been years in the making. There is plenty of blame to go around. Greece has a bloated public sector where retiring at 50 with a full pension has been the norm for decades. Tax evasion and rampant inefficiency were easy to downplay when cheap money was available as part of the newly created Eurozone, and growth was assumed to be inevitable and persistent. The Eurozone, for its part, created a fatally flawed currency in the Euro, where member states could borrow without regard for other members, yet all were jointly liable for the combined debt. This would be like all 50 United States borrowing as much as they each claimed to need, with the other 49 states being automatically on the hook for principal and interest. This is "taxation without representation" taken to the extreme.
After multiple "bailouts" (i.e. loans), Greek debts have mushroomed and become unserviceable. The Greek economy has contracted by almost a third in the past decade, as constant tax increases and cuts in spending have retarded growth:
The problem is quite simple: there is too much debt and not enough growth to pay it off. (It is actually a problem in all developed countries, including the U.S.A.) There are only three solutions: 1.) Default on the debt and walk away 2.) Re-structure the debt so everyone shares in the pain 3.) Create inflation so the currency (and thus the debt) is debased, making it easier to re-pay. (There is actually a fourth solution, which is for everyone to live within their means!)
Greece does not control the Euro, so they cannot inflate their way out of it (#3). The Troika will not allow Greece to restructure the debts since this would mean every bank in Europe would lose money (#2), plus it would send a signal to Italy, Spain, Portugal etc. that it was OK to contemplate the same. So now Greece is trying #1 by defaulting on an IMF payment, and threatening to refuse any new bailout package.
Greek politicians may win the award for public posturing at home, but they have let loose the economic dogs of war which is very likely to sink the Hellenic Republic for good. The newly provoked Troika just tightened the noose around Greece by turning off the money spigot, and they imposed the bank closures and capital controls which will not end until Greece lays fully prostrate before the unelected bureaucrats of Brussels. Greece will be made an example of for any other Eurozone member who wishes to combat this utterly new form of economic totalitarianism. (And it is critical that the lesson is taught now. After destroying the career of Italian Prime Minister Silvio Berlusconi for suggesting that Italy leave the Euro, the Troika is warily eying France, where far right nationalist Marine LePen firmly leads all polls for the upcoming 2017 Presidential election. In the UK, which has already had a taste of stolen elections during last year's Scottish independence vote, skepticism can only be rising about joining the Eurozone.)
All sorts of dire predictions are being made about a "Grexit" (leaving the EU), but it does not seem likely. (For more analysis of the Greek situation, we highly recommend "greekcrisis.net", a blog posted by University of Athens Professor Aristides Hatzis.) Instead, investors will adjust to the increased risk of confiscation of assets and economic blackmail in the EU by seeking safer havens, like (for now) the U.S. Dollar and UK pound. And, since confidence in government is clearly slipping, any public debt (i.e. government versus corporate bonds) is likely to lag. Well run companies with healthy balance sheets and good dividends should see increased interest as the bond bubble unwinds. (High quality U.S. blue chips anyone?)
Another debt problem closer to home exploded into view at month end as Puerto Rico, on the hook for $70 billion of municipal bonds, said the debt was "not payable". This followed the release of a long awaited economic report that painted an ever bleaker outlook for the island's fiscal deficit than previously thought. After years of austerity that resulted in a plunge in growth and tax receipts, this was Puerto Rico's "throw in the towel" moment.
Puerto Rico will now pursue "shared sacrifices", which means that bondholders will be asked to accept debt payment deferrals and extended repayment schedules, among other measures. Unlike Detroit, which filed for Chapter 9 bankruptcy in 2014 as a legal U.S. municipality, Puerto Rico is a "commonwealth", which means it is under the jurisdiction of the United States, and is thus prevented from seeking bankruptcy. There is no "playbook" for this eventuality, so everyone will be learning as they go.
For now though, unwitting investors will be waking up to see dramatic markdowns in some of their bonds / bond fund holdings, as Puerto Rico was one of the most prolific issuers of municipal bonds, and most widely held, due to its triple tax exempt status (no federal, state, or local taxes on the interest payments). Insured Puerto Rico bonds have held up quite well, but this will be a defining moment for the municipal bond insurance industry, as they jockey for seniority to avoid claims.
The peculiar juxtaposition of both the Greek and Puerto Rico debt debacles flaring up at the same time is a reminder that a "day of reckoning" for the debt fueled growth of the past is growing closer. Certainly both instances have shown that austerity measures do not produce growth. Greece in particular has shown how generous pensions promised in the past are unsupportable Ponzi schemes. A great change is coming, whose epicenter will be in the political arena. The first salvo in this new economic war has been fired, as the Troika has banded together to subjugate "the meek", preventing them access to even their own money. Expect lots of push-back from "the 99%".
That's a wrap for this month. We hope everyone enjoys the big July 4th weekend, and perhaps some downtime for summer vacation. Thanks for reading our Journal. We'll be back in early August!
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