Oh momma I'm in fear for my life from the long arm of the law
Lawman has put an end to my running and I'm so far from my home
Oh momma I can hear you a'crying you're so scared and all alone
Hangman is comin' down from the gallows and I don't have very long
Lawman has put an end to my running and I'm so far from my home
Oh momma I can hear you a'crying you're so scared and all alone
Hangman is comin' down from the gallows and I don't have very long
Watch the Steelers version of Styx Renegade here...Pittsburgh Steelers-Renegade
"The jig is up, the news is out." Is the jig up for the municipal bond market? Well, from the way the market has been acting you would think that America's cities and states are in worse shape than the European PIIG'S. OK, some of them are, but nowhere near the number that would justify this magnitude of a selloff. Those of you who read my meanderings know that I've talked about the imminent bankruptcy (oops, I should say restructuring) of Harrisburg, Illinois, and California's debt, but not all municipalities and definitely not all bonds. The hangman may be coming down from the gallows, and more than a few municipalities don't have very long, but not all of them.
Yes, what we have here is a failure to differentiate, or indiscriminate selling. And when you have indiscriminate selling you have opportunities.
The selloff started in earnest after the December 19 "60 Minutes" piece where Meredith Whitney makes some dire predictions about potential municipal bond defaults (see CBS 60 Minutes Chris Christie Meredith ... ). But the drop in municipal bond prices (increase in yields) is more a function of the muni-markets illiquidity than municipalities financial problems. Open-end muni funds have now suffered nine straight weeks of selling, totaling some $16.645 billion, a considerable sum in a rather illiquid market. Some illiquid closed-end muni funds have sold off even more dramatically.
I am loath to recommend specific securities in this letter, because the muni market is highly fragmented, but here are a couple of examples of where things are trading today. If you want more detail give me a call, and as always please do your own homework.
Here in the great Commonwealth of Pennsylvania you can buy AA rated 20 year Pitt or Penn St. Higher Education bonds yielding about 5%. That's 5% state and federal tax-free, which is a taxable equivalent yield of about 7.70%. Or you can buy fully taxable BBB rated Mexican or Columbian government bonds yielding 5.75%.
For those of you with a higher risk appetite you can take a look at a couple of closed-end PA muni funds managed by Blackrock or Nuveen selling at discounts to their NAV's, and yielding in excess of 6% tax-free for a taxable equivalent yield of more than 9%.
Forecasts of massive municipal defaults totaling hundreds of billions contrast with actual experience. S&P reported that total municipal defaults in 2010 were $2.65 billion, which is just 0.095% of the $2.8 trillion muni market.
The jig may be up for several municipalities, and a bigger default/restructuring (especially on the state level) may create more panic selling, but indiscriminate selling creates some attractive opportunities for those willing to do their homework.
Oh momma I'm in fear for my life:
Fear is a very interesting emotion in both life and investing. Fear is an innate emotion, it is a basic survival mechanism. It is a required response to a specific stimulus to avert danger and/or more pain. It is our ability to recognize danger, and run like hell from it to escape, or if we can't escape to stand and fight. Fears can also flip to an irrational reaction to negative forces, often an overreaction. And when fear becomes entrenched it turns into a phobia.
We as humans often fear the unknown, and we overcome this fear through knowledge. Knowledge doesn't help much though when rules are manipulated/violated, and we never really know what is fundamentally real and what is artificially created by the government. When capitalism is allowed to work, with failure being the outcome for poor decisions, we have nothing to fear. Lately there has been a real disconnect between the economy's fundamentals and what is happening in the markets.
Former Merrill Lynch economist David Rosenberg put it best when he recently said, "The economy remain's on government assisted life support, and the government has been very successful in creating the illusion of economic prosperity. It is doing this to buy time and help preserve social stability as the adjustment towards housing deflation, consumer de-leveraging, and chronic unemployment takes its toll on the growth rate in organic final demand."
Where we stand today:
1) Cheap Money = Speculation - The Fed's zero rate policy and quantitative easing have clearly increased investors risk appetite. It's working so far, but just like plastic surgery, what looks good initially can look pretty scary when taken to extremes.
2) Inflation is the Fed's Destination - The Fed is hoping that all of this excess liquidity finds its way into capital spending and job creation, and it appears that some of that is happening. The problem arises in the fact that they can't control where that liquidity ultimately flows, or where the jobs may be created. With all of our excessive regulation and taxes it is not surprising that a lot of the hoped for job creation is happening in emerging markets. This is resulting in inflation (sometimes rather dramatic) in consumable resources (sugar, cotton, rice, oil, etc).
US Equities --
Bullish, stocks are showing no signs of weakening yet, but investors bullishness is getting extreme.
Int'l Equities --
Bullish, especially emerging markets, but developed markets slowing somewhat.
US REITs --
Bullish, but showing some signs of tiredness.
Int'l REITs --
Bullish, but nearing neutral.
Gold -- Bullish, but moving in a range near record highs.
Commodities --
Bullish, but overbought after a strong year-end rally.
US Fixed Income -- Bearish, minimal weight in US fixed income but neutral in TIPS.
Int'l Fixed Income -- Bearish, in developed market sovereign debt, but neutral in emerging markets and inflation protected securities.
Cash Equivalents & Currencies -- Currently at 12.5%, divided between US, China, Australia, and Brazil.
After a fairly strong, government assisted, rally in all equity markets and commodities, I wouldn't be at all surprised to see a noticeable pullback over the next several weeks that may knock us down to neutral exposures in those markets.
Be careful out there, and keep the light's on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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