Sometimes It's Where You Don't Go

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by: Mark J. Grant

Sometimes it's where you don't go that makes all of the difference. After fifteen years of writing "Out of the Box," I have learned a few things. When you stick your neck out on the chopping block, each day, as I do, it soon dawns on you that "avoidance" is a critical part of getting it right, in the markets. Actually, I would go even further. A decent "warning" is far more important that a decent "idea."

I am quite conservative when it comes to investing, and I happily admit that with a smile. I find no joy in being in the wrong place at the wrong time. I am my own worst critic, you see, and I can beat myself up far better than any of you.

I am also very old fashioned. I will not transact in securities that I warn about in my commentary. As examples, since I first warned about Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), I have not done one trade in those securities, except to sell them for institutions that accepted my logic. I follow my own advice.

Generally, it is not that I have hard and fast opinion about the outcome. Rather, it is that I have identified the "risk." If you focus on "risk identification," and not "outcome probabilities" you will find, I believe, that you have better judgment than many others who get caught in the trap of prediction. Prediction opens the door to personal prejudices and, often, these are very poor lenses to make sense of the future. They cloud your vision.

Another sector that I have avoided are Tier One bonds issued by European banks. I have stated, for years, that the risk of them blowing up is far greater than the yields offered. I have been quite steadfast in this opinion, even though my conclusion has been battered about by many lead banks who point to the fact that not one has blown up yet. Ah yes, there is always the "yet" in this discussion.

Well, "yet" may now be arriving, as the Financial Times, today, points to Spain's Banco Popular (BPESY (OTCPK:BPESF) Tier One debt. Prices for their perpetual securities, according to the FT, dropped to $55 and $48, indicating that default may be imminent. Yields here are now around 80%, according to Bloomberg data. The shares of the bank are down 33%, so far, this year, and, consequently, triggering one of the provisions of these bonds, a conversion into equity, will not do anyone, in my opinion, any favors.

Tier One bonds are usually issued by banks to meet European regulatory requirements. The securities, which are the riskiest part of a bank's capital structure, except for its equity, are designed to absorb losses at times of distress. This is accomplished by a conversion into equity or being written down, when the lender's capital ratio falls below a designated point.

If "yet" does arrive, as I believe it will, there will be collateral damage, in my estimation. Other Tier One bonds have not been affected much, so far, but I think the actual determination of a default will have far reaching consequences. I suggest a serious consideration of any of these bonds, that you might own, before the situation deteriorates. Serious "risk" is present.

Other areas that I have stamped with the "risk" emblem are American centric. These include sub-prime auto asset backed bonds which could be our next sub-prime real estate conundrum. Auto sales have soared, in recent years, but I do not think it is because of the price or new technologies. They have been buoyed, in my opinion, by very cheap loans and easy credit which allowed for many buyers who were actually unfit, credit-wise, to buy these vehicles. Sound familiar? I hope we won't be re-visiting 2008 again!

Another "risk" asset, in my opinion, are CMBS bonds attached to shopping malls and other retail spaces. Amazon (NASDAQ:AMZN), and other internet sellers, are eating them alive, in my view, and I don't see it ending anytime soon.

"Needless Mark-up," er "Nieman Marcus," (NMG) and the like are in serious trouble because the same goods can be obtained, and delivered to your door, for far less cost and aggravation. Traditional retail is shrinking, and quickly, as CNBC reports that Michael Kors (NYSE:KORS) will be closing 100 to 125 stores in the near future. The collateral damage here is the real estate, and its debt, where these stores reside, particularly shopping malls. Forbes estimates that 7,000 to 10,000 retail stores will close this year as the "risk" component grows significantly.

Some other American spaces, where I have previously expressed concern, reside in the municipal bond market. I have often discussed the "risk" in Municipal pension bonds and I reiterate my concern today. If a city or county, such as Fort Lauderdale, Florida, which is current on its payments, then it is one thing. If a city or county is far underwater, such as many Municipal pensions in Connecticut, where the Hoover Institute estimates that they are underfunded by $68 billion, then you can stamp "risk" on those credits and perhaps you should review your Municipal holdings again.

I also see "risk" written all over tax-free and taxable hospital bonds now. Much has been written about how the Obamacare repeal or replace or revised, or whatever, will affect the health care industry. Yet little attention has been paid to what might happen to the hospitals when/if some new legislation is enacted. I see nothing but negatives here and this is one more area where "risk" is unquestionably present. One more reason to review your portfolios, in my opinion.

Risk comes from not knowing what you're doing.

-Warren Buffett

Now you know and it is time to get doing!