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Hedge Funds Take Muni-Bond Market By Storm

Something big is cooking in Puerto Rico, and it demands our immediate investment attention.

For the last seven years, the beleaguered Puerto Rican economy has been mired in the muck, enduring GDP contraction in five of those seven years.

To keep the commonwealth afloat, policymakers have suffered through innumerable debt offerings, which now tally roughly $73 billion, according to bond documents.

But did Puerto Rico just hit rock bottom in February?

Likely so.

In February, the three largest rating firms slashed Puerto Rico’s credit below investment grade, citing “liquidity problems” as the culprit.

Since then, however, the commonwealth has been getting tons of “big money” attention.

Puerto Rico’s mid-March bond issue (valued at $3.5 billion) is now the largest U.S. municipal junk bond sale in history.

Trading of the bonds has been fast and furious, with demand outstripping supply by a huge margin.

Orders totaled more than $16 billion from 270 different accounts.

The second-most-popular bond in the first quarter had orders totaling only $131 million.

Yields on the bonds have spiked as high as 9.425%.

Time to Follow Paulson into the Caribbean? Puerto Rico Municipal Bond Yields

But here’s where the story really gets juicy…

Hedge funds accounted for roughly 70% of the Puerto Rican bond issue.

Why is that significant? Because hedge funds rarely dip their toes into the municipal bond pool.

Och-Ziff Capital Management, Paulson & Co, Fir Tree Partners, Perry Capital LLC and Brigade Capital Management each bought more than $100 million of the bonds.

Billionaire hedge fund manager, John Paulson, is among the believers, saying that “Puerto Rico will become the Singapore of the Caribbean.”

Paulson has municipal debt interests in Puerto Rican hotels and continues to strategically add to his Puerto Rican portfolio. In fact, he’s on pace to invest $1 billion in the territory over the next two years, mostly through real estate.

The fact that Puerto Rico’s governor just announced that it will balance the budget without selling debt – for the first time in 20 years – only adds to the investment appeal.

One particular stock now stands ready to explode as a result of the situation.

Onward and Upward,

Robert Williams

Founder, Wall Street Daily

More Storylines Impacting Markets:

Lowest Current Account Surplus Ever for Japan

Japan recently posted its smallest current account surplus on record, counter to Prime Minister Shinzo Abe’s efforts to achieve growth through exports.

The $7.76-billion surplus was significantly lower than the $41.11-billion surplus registered last year.

Abe’s aggressive monetary easing policy, begun 17 months ago, was designed to decrease the value of the yen, thus producing lower prices for Japanese exports. While the yen has fallen more than 26% since initiating his plan, Japan has consistently posted record trade deficits, and it’s seeing increased import valuations – mostly due to higher energy costs.

Prior to the introduction of Abenomics, Japan routinely produced $98-billion annual surpluses. Once interest rates start to rise, Japan will face funding problems that could lead to an economic crisis unparalleled in its history due to its declining population and 240% debt-to-GDP ratio.

A House of Cards

The four largest economic areas of the world are showing signs of debt saturation relative to their rates of growth. The United States, European Union, Japan and China have a combined public and private debt of nearly $180 trillion – or 4.5 times the level of the mid-1990s.

The abundance of liquidity makes further borrowing and higher leverage ratios of little economic use. This is especially true given the overwhelming evidence that households and businesses are actively decreasing their leverage ratios in order to pay for goods and services out of cash flow.

Evidence is becoming insurmountable in the argument that virtually all the added leverage has been used to inflate the price of stocks and other securities by means of massive buybacks, dividends, LBOs and debt-funded M&A deals.

By contrast, real aggregate demand is 5% below its 2007 peak. Once Wall Street realizes that additional liquidity won’t help the economy, stock prices will fall hard.

Robert Williams