In February 2012, Fitch downgraded JC Penney’s issuer default rating to BB+, one step on the wrong side of the infamous “junk” designation. For the most part, the company’s bonds had little reaction, mostly trading right around par. The Fitch action was not the only “junk” in the company’s future, however, as Moody’s and S&P eventually followed.

It wasn’t until May 2012 that JC Penny bonds sold off any appreciable amount. The 7.4% due April 2037 (a bond serially at risk being such long in maturity) spent much of the rest of the year bouncing between 80 cents on the dollar and par. That was a remarkable feat considering the fact the company’s own results got worse as the year progressed – as did corporate liquidity.

By the time 2013 rolled around, there was serious jeopardy. But by late February, the 2037’s were right back near 90 again (as most of the company’s debt rallied) before the shock of the burn rate in cash flow set in. When the company drew $850 million of its $1.8 billion revolver in April, more than anticipated, it had little effect on the bonds, now trading back into the low 80’s high 70’s. But the $1.75 billion loan from Goldman Sachs pushed bond prices back up toward 90, disregarding another Moody’s downgrade entirely.

Those prices didn’t last all that long, as Q1 2013 results in May showed continued and massive declines in revenue (-16.4%) and same store sales (-16.6%), as well as an outflow of almost $800 million for the quarter. So the bonds are back down near 80 again, while some of the shorter dated maturities trade at slight premiums (out to about 2015).

While some may look at the yo-yo of bond pricing history and see the battle between pessimism and optimism, the volatility to me shows the artificial willingness of “moneyed” interests to look for profits in any issue. These violent upswings take place only because there is a rush of money to fill in any downside perception of over-reaction, regardless of the dangers. The fact that it has occurred in near-monthly moves, in my opinion, is the very sign of momentum seeking.

Bond markets are supposed to be means to discount cash flows far more purely than stock markets. That does not mean there is always a smooth transition from market perceptions of clear sailing changing toward rising default probability. But the JC Penney bonds are not the only example.

Perhaps the most obvious illustration is Detroit munis. The Detroit bond space has been largely caught completely oblivious to the bankruptcy in near real time. For example, the Detroit Revenue bond paying 4.75% due in July 2025, traded at par for almost the entire year. It didn’t trade at a significant discount until mid-June, as if the finances of the city were completely unknown until that time. And then the bond rebounded from around 91 to just below par on July 17. The same is true for the GO bonds and some of the other city-related issues.

For the record, the city filed for bankruptcy on July 18! The fact that Detroit munis were fully complacent until only a month before filing, and bond market investors were still chasing a discount-momentum play until the very day the city went under, speaks to something amiss in the “market” for credit. I certainly don’t want to get into “in the old days” comparisons because paradigm shifts do occur (and they are not always bad), but this tendency of even bond markets to fully shake off “bad” news leading to such price volatility (and downright insanity) is a hallmark of too much “easy money” chasing “hot profit” opportunities.

How could the muni market get so complacent in the face of such obvious deterioration?

Being a rhetorical question, it does not need an explicit answer. When bond markets were means of acquiring interest payments rather than just another vehicle for capturing capital appreciation and volatility scalping, they played a macro role in assigning credit money to essential market participants. That was intermediation.

 

Click here to sign up for our free weekly e-newsletter.

“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, contact us at: jhudak@4kb.d43.myftpupload.com or 561-686-6844 . You can also book an appointment for a free, no-obligation consultation using our contact form.