Market Musings Blog

Puerto Rico Causes Municipal Debt Tremors

Even since the Great Recession, municipal bonds have seen more trouble than is normal for this usually super-safe segment of the bond market. Several municipalities in California filed for bankruptcy (Stockton, Vallejo, San Bernardino), then there was Detroit, and now we have the Mother of them all, Puerto Rico.

I won’t bore you with the myriad interesting things about Puerto Rico’s bankruptcy, which is truly special in so many ways – except for this one ominous item. Judge Laura Taylor Swain, who is overseeing the bankruptcy of PR, ruled in mid May that revenue bonds backed by revenues could not, in fact, be paid by those revenues in bankruptcy situations until relief is granted from the automatic stay triggered by the filing itself. This was quite a surprise to participants.

Revenue bonds were heretofore assumed to have a direct lien on revenues that are generated by projects financed by the bonds, such that they stood above the fray in a bankruptcy filing. That meant that so long as the revenues were still being generated, the bonds would be paid. This is how Vallejo worked, for instance; Vallejo taught us that in fact GO bonds were vulnerable. GO bonds had always been thought to be of the highest quality, since their repayment could simply be secured by raising taxes. Instead, Vallejo’s revenue bonds turned into the champs, as revenues kept coming in, for electricity payments, sewer and water payments, and so forth. Meanwhile, everyone has found out that a bankrupt municipality can rarely raise taxes.

So now, derived from the PR proceedings, we have now been told in no uncertain terms that the court will decide the disposition of every iota of cash, not relevant bankruptcy code.

Of course this will go to appeal. However, it’s a very interesting development for municipal bond holders, who have just been reminded that if your bond issuer ends up in court, you might as well throw out the debenture. You’ll just have to wait for the courts to give you what crumbs can be spared.

Buckle Up

By now everyone has noticed that 2018’s stock market is far different from 2017’s stock market. The first round of volatility was blamed on higher interest rates. But in fact by then the tax cut had passed and it’s pretty common for stocks to sink after the realization of an expected event. Investors have a phrase for this: ‘buy the rumor, sell the news’. Stocks discount future news, so good news is already anticipated in stock prices. Since reality is often disappointing versus anticipation, such selloffs are normal.

Then, folks started to fret about deficits after the budget deal was signed. Most recently, volatility is blamed on political uncertainty around trade tariffs.

But it could be anything. After enormous returns in the last few years, the market is ready to view the future with skepticism. Under another president, with a different cabinet, provoking completely different events, the market would still be more volatile than in the last year, when volatility was near an all time low for the longest period ever.

Meanwhile, world growth is slogging along, not at a great rate but definitely in the upward direction. Oil prices are higher, housing prices are rising and sales are solid; construction is robust as states finally improve infrastructure. A generation of citizens is finally healing from the Great Recession, with employment prospects excellent and wages rising. The tax law in the US has inspired other countries to think about reducing tax burdens, and foreign companies are considering locating in the US. It is true that debt has been increasing worldwide, which could turn into a major problem down the road. But the weight of the evidence so far is on the positive side.

So we would counsel looking past the volatility and keeping an eye out for buying opportunities. Identify a few stocks you’d like to own, set a price you’d like to buy at, and then wait for it.

The Mystery of Traditional IRA Withdrawals

We are asked more often these days about required minimum withdrawals – how they work, why they must happen, and particularly, can taxes on RMDs be avoided.

The concept of the IRA contains an implicit agreement between you, as the IRA owner, and the federal government. The deal is this: you get to put away money (and often deduct those contributions), and you get to accumulate your earnings tax free, but only until you turn 70 ½. (No, we don’t know why the age 70 ½ was chosen, except it seems to be a compromise between retirement age and ‘really old’.) Once you turn 70 ½, the IRS wants its pound of flesh, and it insists that you draw the money out on a schedule that’s designed to exhaust the IRA, or nearly so, during your lifetime, so that money can finally be taxed. Overall, it’s a good deal, since it is better to pay taxes in the future versus today. (The ROTH flips this relationship on its head, agreeing that if you pay tax now, you get to get out of paying tax during accumulation and later.)

The tax on RMDs really can’t be avoided. The closest to avoidance is the Qualified Charitable Distribution, which allows you to donate your RMD or part of it directly to a charity (not your own foundation by the way). In that case, the tax on the withdrawal is nearly or completely cancelled by the deduction for the donation.

One hallmark of IRA RMDs is that they generally grow larger the longer you live. The RMD calculation uses the 12/31 prior year market value and your age and life expectancy to come to an amount that must be drawn (inherited IRAs and IRAs with young beneficiaries use other factors in the calculation as well). Each year, your RMD can rise due to a higher market value and/or a shorter life expectancy. The table below shows how life expectancy can affect draws:

As you can see, living into your 90s kicks off a 10% withdrawal rate.

The gradual acceleration of withdrawals makes management of this process critical. High cash flow – ie, choosing stocks with higher than average dividend yields and gearing the bond portion of the portfolio towards higher yields – is one way to deal with the depletion of the IRA asset base. More risk tolerant investors might want to trust capital appreciation in stocks to ‘pay for’ their distributions, but in a bear market, that can produce a disaster.

However one chooses to manage the distribution phase of traditional IRAs, it’s wise to remember that when staring at a $1 million IRA, you don’t really have $1 million; you have $1 million minus the tax that will be paid as that asset base pays your RMDs. This is a critical fact for retirement planning.

Market ‘Dips’ and Market ‘Corrections’

As the market sank this last week, we had a few comments from clients about this ‘rocky ride’. (One note of appreciation – these clients were calling with more concern for us than their portfolios! Thanks for that!)

Now is a good time to review a few statistics about market movements. First of all, it’s hard to remember this after last year, but nearly every calendar year since 1926 has contained a ‘dip’ of around -5% to -7%, and many years have contained more than one ‘dip’. On average, these moves happen at least every year, and over some shorter time frames, they happen twice a year! So we can consider this kind of movement normal. What’s not normal is going without a 5% correction, like we did last year.

Furthermore, ‘corrections’, of more than -10%, happen about 2/3 of the time, also within the range of normal.

One alarming feature of both dips and corrections, which tends to imbue them with more importance than they deserve, is that they happen fast. Markets rarely slide centimeter by centimeter over a long period of time. Instead they tend to plunge. Meanwhile, the recovery from the dip or correction can take months, making this feel all the worse. However, recovery occurs – so far – 100% of the time. So using a correction or a dip to buy assets is smart, provided the increased exposure synchs up with your financial plan.

An Addendum on Security

We had some feedback to our earlier blog on security, specifically around passwords. Our commenter indicated that her passwords were turning out to be too weak and she suggested that we augment our earlier post with some sites that can improve password quality – a worthy suggestion.

Here are a few password generators:

If you just want to check your own chosen password for strength, try this site:

Additionally, there are a number of services to keep track of all your odd passwords, but of course you have to remember your master password – and that one can be hacked too. We often use Roboform, here:

Happy browsing!