Greece

If you’ve been near a TV or computer this morning chances are you are aware today has been a not-so-nice day for long investors. Thankfully it is not nearly as bad as the last time Greece was the big story. Still, we felt some perspective-sharing might be in order.

At the time of this writing the stock market is officially down for the year. It’s been bumping around in a fairly tight range in 2015 however today’s 200+ down move puts us in negative territory. We have not been caught flat-footed. We have said consistently that 2015, in our opinion, would be a negative year for the broad stock indexes. It is too early to know exactly how things will shake out but we have been shifting portfolios all year to mitigate downside risk.

The big news today is Greece has closed its banks for a week and limited the daily withdrawal of funds from ATMs to an equivalent of $66 USD. This in front of Greek Prime Minister Alexis Tsipras’ call for a national referendum this coming Sunday which may effectively decide if Greece stays in the Eurozone. Unfortunately the referendum is not that simple, as the question before voters will be:

“Should the agreement plan submitted by the European Commission, European Central Bank and the International Monetary Fund to the June 25 eurogroup and consisting of two parts, which form their single proposal, be accepted? The first document is titled “Reforms for the completion of the Current Program and Beyond” and the second “Preliminary Debt Sustainability Analysis.”

Not approved / NO
Approved / YES

We do not question the economic and political savvy of Greek voters, we merely question how many will study the two aforementioned documents before voting.

Regardless of outcome (which we choose not to predict) we believe at this time that the probability of a Greek contagion spreading across the EU and eventually across the Atlantic is neither as likely nor as worrisome as in 2008 and again in 2011, and 2012.

China

Perhaps more worrisome than Greece is China. China’s Shanghai Composite Index is down roughly 22% in the past two weeks (June 12th high), falling another 3.3% today which officially put it in a bear market. Today’s market drop is the result of a surprise interest rate cut aimed at shoring up recent unease. Investors worry that the rate cut signifies that things are worse than previously thought.

Puerto Rico

What really has us chewing our fingernails however is Puerto Rico. The Commonwealth of Puerto Rico is a United States Territory of roughly 3.6 million people. This morning The New York Times published Governor Alejandro Garcia Padilla’s remarks that Puerto Rico will soon be unable to pay its debts.

Though Puerto Rico is not a state the US has plenary jurisdiction over it since the Puerto Rico Federal Relations Act of 1950. This means that people born in Puerto Rico are natural-born US citizens and laws enacted at the Federal level in the United States apply to Puerto Rico. However, Puerto Rico does not have voting representation in the U.S. Congress.

Being a US Territory bonds issued by the government of Puerto Rico are federally tax free and have been popular investments for those seeking tax free income. What happens if Puerto Rico defaults? No one really knows. The most likely scenario is a “restructuring” of bonds where existing outstanding bonds are changed to longer, fixed maturities with lower coupons. This is not good news for bondholders. The effects of such a restructuring would ripple throughout the municipal bond market. Many Puerto Rican bonds are insured, meaning the insurers may take a massive hit as well, jeopardizing their ability to adequately insure other bonds from US States. If the quality of insurance on an Ohio bond is diminished shouldn’t that mean that the risk of owning that bond rises? If so, shouldn’t the price of that bond drop?

We don’t know how this will shake out, in spectacular fashion or with a whimper but know this: Monarch Asset Management does not own a single Puerto Rican bond in any client account, nor have we since our founding.

Final thought: It is beyond time for Puerto Rico to become our 51st State. The most recent poll shows that its citizens agree. Being subject to our taxes, our laws and having no representation sounds awfully familiar to a lesson I remember from grade school. Nationally, Republicans are frightened at the prospect of granting statehood and two Senate Seats to a Territory that aligns with the Democratic Party, but in this author’s (and professed Republican’s) opinion they need to get over it and start appealing to those potential voters.