One More Thing... Crouch Connection, December 2015


In the November edition of the Crouch Connection, I mentioned four factors that were concerning me and how they might affect the markets:

  • The looming Fed rate hike.

  • The possibility of an even stronger Dollar.

  • Lower oil prices.

  • Emerging markets turmoil.

In addition, there are several issues that I monitor that could be a problem for our economy if they develop further, but at the time of last month's writing I did not believe they were currently causing problems. That changed last week.

Junk Bond Selloff

Last week investors with Third Avenue Management learned that they would not be allowed to withdraw cash for several weeks or months due to the sheer volume of redemption requests and lack of liquidity in "high-yield" bonds, or in industry lingo, "junk bonds." These are bonds that are issued by companies that are riskier that traditional "blue chip" companies, and as a result pay higher interest rates to the investor.

The problem is that there is a higher risk of default from these companies, and the bigger problem is that too many investors ignore that risk until it is too late. Much like the proverbial movie theater catching fire, when too many investors pile into one asset class, there aren't enough doors for everyone to escape when the fire breaks out. And that is now the case with junk bonds.

The devastation in the oil patch has not only caused many Americans to lose their jobs, but it is causing severe cash flow problems among the companies in the oil and natural gas industry. Just like the tech bubble in the 1990s, the high price of oil of the past few years has attracted the money of many Americans eager to loan funds to these "attractive" oil companies in an attempt to profit from the excitement of the oil boom.

Much like the technology crash after Y2K (remember that?), oil prices have now fallen back to levels not seen in many years, and many of these once promising companies are now in danger of defaulting on the bonds that Wall Street sold to the eager investors. Last week's announcement was just the first sign of problems for investors in junk bonds.

"There's Never Just One Cockroach"

Jeffrey Gundlach, chief investment officer at DoubleLine Capital and well-known in the industry as one of the smartest brains in the business, made the cockroach comment in an interview recently. Gundlach has been warning investors for months that the junk bond market could create havoc in financial markets and possibly stay the Fed's hand as they try to raise rates. The cockroaches he was referring to are the dozens of other "high-yield" investments out there that could easily have similar problems.

Similar problems have surfaced in the hedge fund industry in recent months as some hedge funds have suspended liquidations and reported significant losses to their investors in "high-yield" funds. But hedge funds are a different animal and don't alarm markets so much when things go wrong. Investments sold to the general public are an altogether different proposition as they are generally thought to be liquid on a daily basis.

According to The Wall Street Journal, this "growing tumult in the credit markets comes eight years after BNP Paribas SA helped spark a global financial crisis by freezing withdrawals from three investment funds because it couldn't 'fairly' value their mortgage holdings." The similarities to the financial crisis of 2008 are troubling.

Time for Caution

The bottom line is that our recent caution seems now to have been warranted. We believe It is a time to be in the "blue-chip" investments, along with a few "alternative" investments that have historically been counter-cyclical to the general stock market.

If you have concerns that we haven't addressed here, please give us a call. We always enjoy conversations with our clients and encourage you to let us know when you have questions. Thanks again for your friendship and your business. We have the best clients in the world!

P.S. Our apologies to our friend Ken Peterson, manager of the Regal Cinemas in Green Hills ... pardon our movie theater illustration. We know, modern theaters have fire suppression devices to put out the fires, so don't let us discourage you from going to the movies this holiday season!

"You only find out who is swimming naked when the tide goes out."

-- Warren Buffett

This information does not purport to be a complete description of the securities, markets or developments referred to in this material; it has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. This information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment decision. Any opinions are those of the authors and are not necessarily those of Raymond James. Expressions ofopinion are as of this date and are subject to change without notice. Past performance is not a guarantee of future results.

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