Puerto Rico: Bogus Claims of Default?

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Bogus Claims of Default?

“We’ve proven Puerto Rico is NOT Detroit nor Greece.”

Governor Alejandro Padilla, April 2014 (after selling $3.5B bonds to investors)

A funny thing happened along the way to default, Puerto Ricans started to actually pay their taxes.  By some estimates, up to 35% of the countries’ GDP is underground, not accessible to tax collection.  Recent data shows this may be starting to change.

Government of Puerto Rico revenue for 11 months of Fiscal Year 2016 totals $14.9 million more than estimated in the budget, according to figures released yesterday by Treasury Secretary Juan Zaragoza, calling into question claims that Puerto Rico cannot pay its debts.

U.S. Treasury Caught Speeding?

The U.S. Treasury has been painting a dire picture for Puerto Rico.  In an effort to cram down investors, achieve debt forgiveness from bond holders, most investors feel the Treasuries’ recent claims have been unfounded.

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Puerto Rico new

The territory has collected $8.2 billion, compared with $7.9 billion during the same period of Fiscal Year 2015.

Puerto Rico

Debt vs. Population

2016: $72B vs 3.5m people

2006: $38B vs. 4.6m people

Bloomberg data

The major change in revenue was in the Sales and Use Tax, which was increased from 7% to 11.5% during the year. After payments on bonds issued by the Sales Tax Financing Corporation (COFINA), the levy contributed $1,355.8 billion into the treasury compared with $510.9 million last fiscal year. The amount was $27.1 million more than expected.

Individual income taxes were down from $2,106.2 billion to $1,854.3 billion, $10.4 million less than expected. Corporate income taxes edged lower from $1,478.2 billion to $1,434 billion, but were $53.6 million more than budgeted.

The 4% tax on products received by companies in the States from their manufacturing subsidiaries in Puerto Rico generated $1,675.7 billion, a bit less than the $1.741.1 billion last year and $24.8 million less than expected.

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Bond Madness

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If it was a fight, they’d stop it.  Bonds are crushing stocks 2014-16.

We have a Swiss bond below, a move 100 to 230 at nosebleed levels.


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Japanese, German and Swiss bond yields plunged to records, as government debt around the world extended its best gains in two decades, with the prospect of Britain leaving the European Union boosting demand for havens.

Brexit Risk is creating extreme panic buying in bonds.  They’re jumping over the seats, swinging on the chandeliers, trying to get out through the bath room window, all in an effort to buy bonds.

Everyday the Fed doesn’t hike rates, they’re shoving more capital in places it just shouldn’t be

Federal Reserve Chair Janet Yellen fueled the rally by saying Wednesday slow productivity growth and aging societies may keep interest rates at depressed levels. Fewer Fed officials expect the central bank to raise interest rates more than once this year than they did three months ago, based on projections the central bank issued. The Bank of Japan said inflation in the nation may be zero or negative, while holding monetary policy unchanged.

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EU Banks Through the February Lows

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EU Banks are now through the February “crisis” lows.  It’s just a matter of time before Mr. Market vetoes NIRP or Negative Interest Rate Policy.

Negative rates are crucifying European financial institutions as the easy money made on short term net interest margin has vanished.

EU Banks through the February Lows

EU Banks

Similar to the GOP establishment and Donald Trump, Central Bankers are confused, don’t understand the risks they’re creating and don’t know what to do next.

On May 31st, we recommended our subscribers get long volatility, join us here:

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One of our classic 21 Lehman Systemic Risk Indicators is found in Deutsche Bank 5 year sub CDS.   When people are paying up for default protection on a bank this large, beware.

Cost of Default Protection on Deutsche Bank


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Pure Evil

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Price to Earnings, Debt to EBITDA, Price to Book; these are the values that used to drive stock market prices.

Not today…

Per the New York Fed

“We document large average excess returns on U.S. equities in anticipation of monetary policy decisions made at scheduled meetings of the Federal Open Market Committee (FOMC) in the past few decades. ”

Breaking: NY Fed Note

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Recession Odds Surge to 55%

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Wall St. is finally waking up to recession risk.  The credit markets have been warning us since last November, but U.S. economists have been in deep denial.

What are plummeting interest rates saying about the outlook for the economy? The spread between the yield on 10-year U.S. Treasury notes and two-year notes is the narrowest since 2007. A model maintained by Deutsche Bank analyst Steven Zeng, who adjusts the spread for historically low short-term interest rates, suggests the yield curve is now signaling a 55 percent chance of a U.S. recession within the next 12 months. That marks the highest probability generated by the model so far in this expansion, and may be a cause for concern as Federal Reserve officials meet this week in Washington to discuss next steps for policy. – Bloomberg


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Stock Market Volatility, 3 Things You Need to Know

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Time To Sell Volatility

How We Look at the VIX, Chicago Board Options Exchange Volatility Index

“The Trade: We believe the risk – reward in getting long volatility is the most attractive since last November. We are buyers of the VXX ETN.”

The Bear Traps Report, May 31

On May 31st, we stressed to subscribers there’s value in buying volatility during holiday shorted weeks.  In recent years, we’ve witnessed a collapse in volatility during light volume trading weeks near holidays.  This is especially true in and around month end / quarter end.

Dramatic Shift in the VIX Futures Curve


Over the last 15 days, the VIX has surged from 13.12 to 22.15.  On May 31, we made the point to subscribers that volatility was mispriced relative to Brexit, China and U.S. election risks.

“When funds crowd together they buoy trades well past arguable fundamental valuation, next all race out together.”

Paul Tudor Jones

Central bankers keep moving the entire student body left, then the entire student body right.  Negative interest rates globally have investors thirsting for yield and alpha, the net result has been some of the most crowded trades we’ve ever seen.   What many investors don’t realize is you can use this phenomena as your friend or your enemy.

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Our research shows, in the post Lehman era, as Fed policy has had more and more influence over market performance, stock market volatility has substantially plunged (cheapened) around holiday shortened weeks.  Memorial Day, the Fourth of July and Thanksgiving are prime examples below in the chart.

VIX Holidays2.gif

“In acknowledging global economic risks, shooting the March rate hike right between the eyes and then talking the dots from 4 to two.  The Fed drowned market volatility, held its head under the water and watched for the bubbles.  Now is the time to buy it on the cheap.  Buy the VXX ETN (iPath S&P 500 VIX Short-Term Futures ETN)”

Bear Traps, May 31st, 2016

VIX may 31 call

A few weeks ago, we were between Fed meetings, thus making them ideal occurrences for maximum volatility suppression.

In the weeks ahead of the “widely expected” March rate hike (in January 83% of Wall street’s economists and strategists said the Fed would hike again rates by March).  The dollar surged, oil plunged and the street panicked and sent the VIX to its highs for the year in mid-February.

Next, the Fed took out their fire hose, they shot the March and June rate hikes between the eyes.  The dollar plunged, commodities and emerging markets soared, “risk on” was born again.

As the Fed has backed off their beloved rate hiking policy path, the VIX plummeted to around 13 in late May.  The same people who were caught holding plunging stocks in February, were telling us to sell volatility, this was a sure buy signal.  Again, volatility was clearly mispriced relative to Brexit, China and U.S. election risks.

VIX Futures Curve: From Steep Contango, to a Move Toward Backwardation

Today, the spread between the VIX 2 month futures contract vs 8 month coming way in, the most substantial curve flattening since mid April.

VIX Futures Curve

Description Last
Jun16 21.7000
Jul16 ↓21.5700
Aug16 21.4300
Sep16 21.7300
Oct16 22.0300
Nov16 ↓21.9900
Dec16 ↑21.7500
Jan17 ↑22.5500
Feb17 22.6000

VIX 2 vs 8 Month

Market bottoms are typically found during periods of backwardation in the VIX futures curve, see above.

How We Measure Risk and Reward

Let us explain, on February 10th investors were paying up for near term downside insurance on stock prices.  The front month VIX futures contract was trading substantially higher than the longer term outer months.  In other words, the March contract was trading rich to the September contact (see the green above in the chart).

In the fear of February, this was a buy signal for stocks; we recommended our subscribers to get long financials and oil names in our Bear Traps reports and on CNBC.

In recent weeks, the opposite has occurred, the VIX futures curve went into steep contango.   In other words, the longer term VIX futures contract (December) was trading higher than the near term contracts (June).  When the contango “widens” to extreme levels it is a sign of complacency in the markets, this is one of the reasons we recommended that subscribers get long volatility.

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