Now, the troubles have claimed a major mutual fund victim — the Third Avenue Focused Credit Fund (TFCIX). The fund was chock full of junk bonds, stocks, warrants, loans and preferred shares, and those securities have been plunging in value.
It had lost almost 27% of its value year-to-date, as you can see in this chart …
|Shocking losses …|
Selling its relatively illiquid holdings into a falling market could have caused the losses to get even worse. So Third Avenue Management decided to slam the gates shut on withdrawals from the $789 million fund.
This is shocking, folks. I say that because it’s an extremely rare move for an open-ended mutual fund. No mutual fund has ever halted redemptions without an order from the Securities and Exchange Commission authorizing it to do so.
In fact, we haven’t seen a fund failure even remotely like this since the credit crisis in 2008. That’s when a money market fund called the Primary Reserve Fund “broke the buck.”
There’s no telling how long it will take for fund investors to get all their money back. But one thing is clear: So much money flooded into junk bond funds in a desperate search for yield over the past few years … and losses are so widespread that every single one of the 30 largest high-yield bond funds is showing losses for 2015. That means even more investor withdrawals are likely in this asset class, hitting the junk bond market even harder.
|An extremely rare move for an open-ended mutual fund …|
So what are the consequences for you, and the markets in general?
First, if you own junk bond funds or ETFs, you’re probably losing money on them. There’s nothing you can do about the past. But you can insulate yourself against further losses by selling down your holdings now.
At some point, the risk-reward in owning junk bonds will make sense for fresh investments. Yields will rise high enough, and prices will drop low enough, to make riskier bonds too attractive to ignore. But I don’t think we’re there yet.
Second, what happens in the higher-risk corners of the debt market won’t stay contained there. It sure as heck didn’t in 2007-09, or in other major turns in the credit cycle. As debt market liquidity dries up and prices fall, it will put more pressure on companies that need cheap debt to survive and thrive. It will also cause banks to tighten lending standards on new loans, because they’ll have a tougher time unloading some of their risk on investors.
This is all bad news for publicly traded hedge fund, private equity and money management firms. It’s also bad news for foreign banks, many of which are already reeling from economic problems in South America, Asia, and Europe.
Finally, it’s a key reason why the broader financial sector has lagged the market rally … and why financial stocks in general look relatively vulnerable to me. If you own these kinds of names, sell.
Third, this makes it even more important for you to maintain a much higher level of cash reserves than you have for the past six-plus years. It also underscores why you should consider using downside hedges to protect against losses in vulnerable sectors like financials. In my Interest Rate Speculator service, I’m a bit more aggressive and looking to generate by targeting troubled shares.
Fourth, understand that many investors have been “hiding” in other sectors they believe aren’t as vulnerable to the credit problems. That includes sectors like technology, especially the infamous “FANG” stocks.
But if tighter lending standards, a flattening yield curve, and weak foreign growth weigh more heavily on the domestic economy, it’s going to pressure even those previously resilient kinds of names. So if you haven’t taken some profits on those stocks, or pared down your overall market exposure, this is a good time to do so.
Bottom line: You simply can’t ignore the credit markets if you want to be a successful investor. The first major gating of a mutual fund since the credit crisis in 2008 shows that the problems are getting worse out there, and further illustrates why taking protective action is warranted.
So what do you think about this latest mutual fund disaster? Are you holding junk bond mutual funds or ETFs, and if so, how are you reacting to the Third Avenue news? What does this say about the broader stock market? Do you believe the problems will stay bottled up in energy and commodity stocks, or is this a sign you need to dump other stocks as well? Let me know here at the website.
Market turmoil is definitely on the rise, driven by events in the credit markets. That inspired many of you to weigh in on what’s going on now, and what you expect to happen next.
Reader R.J. said: “There is no doubt capital has been chasing yield anywhere it can for six years now. The Fed’s statement is critical. If they don’t emphasize this is a ‘one and done’ rate hike, then all heck will break loose. If they use the right words, I think the bubble will continue to inflate for at least another year.”
Reader J.P.F. also shared some comments about the upcoming Federal Reserve meeting, saying: “Do we believe Janet Yellen will boost the Fed rates by 0.25% on December 16? Many do. I do not believe this, although I would like to see it.
“The economies of many countries just stink! Ours is even rotting from the bottom, while a rate increase could push some of these ‘walking zombies’ into default. It will not be the worst thing in the world to finally let the cleansing that would have happened after the 2008 bank mess, had the Fed not interfered to save the ‘too big to fail’ companies.”
Where will stocks head next as a result? Reader Jim said: “The trend of the last couple of years has been for the markets to rally to the end of the year, then to decline through January. Then in February, they would start advancing again. I think that this pattern will pretty much remain the same, except that after January, stocks will continue in a decline throughout 2016.”
But Reader $1,000 Gold was more optimistic, at least about select companies: “This is what consolidations are all about. I expect just a handful of large oil companies to survive. But in the mid-to-long-term, everyone will be better off. It’s why Warren Buffet likes large caps. So do I.”
Thanks for sharing everyone. Personally, I can’t help but be cautious, as I have been since the summer. That’s because the message from the credit markets is an unambiguous negative. Unless and until conditions change there, I believe sticking with a cautious investment strategy is a smart move.
Agree? Disagree? Then let me know about it here.
DuPont (DD) and Dow Chemical (DOW) confirmed that they plan to merge in a transaction valued at roughly $130 billion. It will be structured as a merger of equals, rather than a takeover of one company by the other, and will be followed by a re-split of the firm into three new units.
But investors sold shares of both companies today. That could stem from worries about the health of the chemical and agricultural industries, the deal’s complexity, and/or regulatory opposition, among other factors.
While worries about the future direction of the U.S. economy are percolating out there, the government reported relatively strong retail sales in November. Headline sales rose 0.2%, while sales excluding autos and gasoline gained 0.5%. That was the biggest rise since July.
The “Warren Buffett of China” has gone missing, and trading in shares of his investment vehicle Fosun International and related companies worth $34 billion have been suspended. Guo Guangchang has spent billions of dollars buying businesses as diverse as Club Med and Cirque du Soleil, plus banks and insurers at home and in the U.S. and Europe. It also owns real estate, including One Chase Manhattan Plaza in New York City.
But he disappeared several days ago, amid rumors of an anti-corruption investigation by Chinese officials. That caused prices of Fosun bonds to plunge, and helped fuel even more worries about the stability and safety of Chinese markets.
So what additional thoughts do you have about the Dow-DuPont tie-up, now that it’s official? Do you think the strong retail sales data puts to rest fears of a weak holiday shopping season? Or will sales deteriorate going forward? How about the latest news out of China? If you have any comments on these or other topics, be sure to share them below.
Until next time,
P.S. Are you pondering what you should be doing now to preserve your wealth in a world gone mad?
A new report by Weiss Research Senior Analyst LARRY EDELSON has the answers you’re looking for.