Why Detroit’s Bankruptcy Means a Higher Stock Market

Chris Versace

Chris Versace is a financial columnist and equity analyst with more than 20 years of experience in the investment industry.

By now I’m sure you’ve heard the news that Detroit has filed for bankruptcy. Many have speculated whether or not it was the right move to make or not, but the reality is that Detroit did file. I’d point out that Detroit was not the first municipality to file for bankruptcy court protection. Since January 2010, there have been 35 others. That’s a relatively high number over the last few years. While it pales in comparison to the 41,008 businesses that filed bankruptcy in 2012, the fallout of those municipal bankruptcies is good news for the stock market.

Sound a little counter intuitive to you?

Let me explain my reasoning.

In the past, municipal bonds and muni bond funds were considered relatively safe investments. Investors to those products would plunk down their hard-earned dollars and clip coupons until the bonds matured. What made investing in muni bonds even sweeter was the tax-free status they enjoyed.

It’s hard to say exactly when the situation changed, but it’s evident it was sometime in the last few years as those municipality bankruptcies started to climb. A great example is found in the tale of Stockton, Calif. Following the foreclosure of key city buildings and businesses, and three years of municipal cost-cutting that drastically reduced services, such as police and fire protection, Stockton became the largest U.S. city in history to file for protection from creditors under the nation’s bankruptcy laws last June. A few months later in October, investors who once believed it was nearly impossible to lose money with bonds backed by the full faith and credit of a city government were told that Stockton expects them to accept a loss on their investment. As Marilyn Cohen, president of Envision Capital Management, put it, “Stockton makes it clear that general obligation bonds are no longer such a safe haven.”

The bloom is off the muni-bond rose and Detroit is helping those petals drop even faster. Municipal bond funds saw outflows of $1.2 billion in the week ending July 24, on concern that Detroit’s filing for bankruptcy — the largest in U.S. history — will set an important precedent and more cities could follow suit. It was the ninth consecutive week of outflows from the fund type.

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There is nothing like rising risk to crush an investor’s appetite for an asset class that is no longer a sure thing.

At the same time, Fed Chairman Ben Bernanke has stated that stimulus tapering is not on the table near-term as the economy and its recovery remain “fragile.” There have been a number of signs that support that view, and I write about them each month in my investment newsletter PowerTrend Profits. The latest came from the Mortgage Bankers Association (MBA) last week.

“MBA expects economic growth to average 2.2 percent in the second half of the year versus the 2.4 percent originally forecast, with the declines mainly due to reduced fixed residential investment and reduced government expenditures. MBA expects the unemployment rate to be at the 7.5 (3rd quarter) and 7.3 (4th quarter) percent levels forecast at the beginning of the year but cautions that inflation over the next several months will be sharply higher due to higher oil prices and housing rental costs.”

That combination suggests that having risen during the last several weeks, interest and mortgage rates are likely to be capped. The question that will soon be asked is where will all of that mortgage bond fund money go?

With few other viable alternatives, I see those funds being funneled into the stock market, which means the stock market will move higher during the course of the coming months. It is too soon to tell whether or not it will lead to another stock market bubble, but I am concerned about the disconnect between the economic fundamentals and the strong move in the stock market year to date — the S&P 500 is up more than 18% year-to-date and the Dow Jones Industrial Average is up 18.7% on that basis as well.

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The seasoned investor knows there is always a bull market out there. It is just a question of finding and investing in it. That’s what my PowerTrend Profits subscribers and I do each week and it has led to some stellar returns despite the market volatility and economic, as well as political, worries in the last year. By following the PowerTrend method of investing, my subscribers have generated a 60% return in Starbucks and we’re profitable in 13 of our 16 positions.

Breaking Down the Looming Water Crisis. Subscribers to my investment newsletter, PowerTrend Profits, are racking up some nice profits in shares of Xylem (XYL) as part of my Scarce Resources PowerTrend. The company is well positioned to meet the different demands by the looming water crisis that we face not only in the United States but around the world. This week on PowerTalk, I spoke with Debra Coy, principal at Svanda & Consulting and an advisor at XPV Capital. While those are Debra’s current titles, she has been following or involved with the water industry for more than 25 years as an equity analyst at firms such as Janney Montgomery Scott, The Washington Research Group, HSBC Securities and others.

During our conversation, Debra gave a great overview on the water industry and its many facets, from equipment companies like Xylem to water utilities such as American Water Works (AWK) and Aqua America (WTR). We also talk about the looming water crisis, water’s role not only in the home but in industrial and other manufacturing uses (such as semiconductor manufacturing and pharmaceuticals) and how more and more companies around the globe are making critical decisions, such as where a new facility may or may not be located. That’s right, access to water is becoming a key consideration in economic development, and that means jobs.

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Click here to listen to my PowerTalk with Debra Coy
that breaks down the looming water crisis.

It is conversations with CEOs of public and private companies, as well as other subject matter experts like Debra, that offer me insight that the average investor simply doesn’t get. Come profit with my subscribers as I put those insights to work each week — simply click here to subscribe to PowerTrend Profits.

FREE Webinar — I encourage those of you who want to learn more about PowerTrends to attend my free webinar this Wednesday, July 31. You’ll get an in-depth explanation on what a PowerTrend is and how to use them to pick winning stocks. As a bonus, I’ll give you three stocks that I currently recommend to subscribers of my PowerTrend Profits newsletter. You can click here to register now.

To read my e-letter from last week, please click here. I also invite you to comment about my column in the space provided below.

Upcoming Appearances

  • Each Monday, I kick off the week with America’s Morning News as we discuss what’s on tap for the coming trading week. Click here to find a radio station near you that carries the program.
  • Each Friday, I’ll be joining The Andrea Tantaros Show to dissect the latest economic and stock market news with Andrea and her listeners. You can listen to that discussion by clicking here.
  • Join me for the San Francisco Money Show, Aug. 15-17, at the San Francisco Marriott Marquis. There is no charge for this conference, but you do need to register. Call 1-800/970-4355, and mention code #031735.

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