6/30/17 – Stocks Lower in Great Week for Warren Buffett

Stocks finished down in the last week of June, but up for the month and the 2nd quarter. On the week, the Dow declined 0.2% while the S&P 500 declined 0.6%. Next week, markets are closed on Tuesday for the 4th of July holiday, but we will get some important news at the end of the week with the June jobs reports. We’ve had mixed reports the last few months and investors will be focused on the strength of the labor market and what that means for interest rate policy and economic growth. Have a Happy 4th of July Weekend!

Warren Buffett – Six years ago Bank of America was in trouble. It was still reeling from the financial crisis and needed a capital injection. While a risky investment at the time, Warren Buffett’s Berkshire Hathaway invested $5 billion in BoA in return for preferred shares that paid a 6% dividend and gave him an option to convert the shares into Bank of America stock at a price of just over $7/share. The preferred shares paid him $300 million annually in dividends and gave him until 2021 to convert to regular stock. As banks have strengthened, Bank of America announced it would increase its dividend. With the increase, the total dividends on the shares Buffett could convert exceed the $300 million he’s currently receiving. Additionally, Bank of America stock is now over $24/share. So, Buffett converts the shares, continues collecting $300+ million a year and now his $5 billion investment has a market value of $17 billion. Pretty good week for the Oracle of Omaha. It’s also a great lesson in staying the course. He is so good at ignoring the ups and downs of the market and investing heavily when he thinks the price is right. Read More

Illinois Bankruptcy – States can’t technically file bankruptcy like a company or municipality can. The situation in Illinois though is getting lawmakers attention and could lead to changes in bankruptcy law that would allow for a state filing. Illinois hasn’t had a budget in three years, it has $15 billion of unpaid bills and a staggering $251 billion in unfunded pension liabilities. The unfunded pension liability is almost five times the state’s annual spending.

The state pension is only 40% funded, a level many analysts believe is not possible to recover from. 25% of the state’s budget is going into pensions and it’s barely denting the problem. One issue from being so underfunded is the assets essentially can’t grow as fast as the liabilities because the asset base is so small. Even a relatively strong market this year is of minimal help. If the fund is earning a reasonable return, it’s still missing out on so much potential earnings because the fund is only 40% funded. However, future pension obligations keeps growing at the full rate.

Illinois’ state constitution prevents reducing pension benefits which gives the state limited flexibility in addressing the problem. As someone once told me, “If the law says one thing and the math says another, the math is eventually going to win.” That seems to be where Illinois is heading. Large pension cuts and pension reform is the only way this situation gets resolved. This highlights a point I’ve made here numerous times over the years. If you have the option to take a lump sum payment from a pension plan, especially a government pension plan, you should look closely at that offer. Read More

Oil broke a 5-week losing streak, increasing 7.2% to close at $46.20/barrel. The yield on the 10-yr Treasury moved sharply higher, closing at 2.30% from 2.15% a week ago. The average rate on a 30-yr fixed rate moved lower this week, to 3.88% from 3.90% last week.

Close Weekly YTD
Dow Jones 21,349.63 (0.2%) 8.0%
S&P 500 2,423.41 (0.6%) 8.2%
Oil 46.20 7.2% (14.3%)
10-yr Treasury (∆ in bps) 2.30 15 (15)

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