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Archive for the ‘Municipal Market Letter’ Category

Why Municipal Bonds?

June 23rd, 2021 by Kurt L. Smith

The obvious answer to the question “Why municipals?” is they are tax-free. That is a good reason, especially if the benefit is greater than the alternatives. From the days of double-digit yields of the early 1980’s the added benefit of the tax-free feature has almost always been worthwhile to investors in the highest tax brackets.

Of course, an almost forty year bull market for bonds helps as well, but that is over. Bond performance no longer has the wind to its back; bond performance now faces many headwinds. Selection is key no matter the market, but in today’s new bond market, selection is paramount.

The final stages of the bond bull market have wreaked havoc with investment managers and their investor clients. Where is the yield and what has performed well in these final throes of the bull? You know it is junk, or high yield. For municipals this means prisons, nursing homes, dormitories and other housing or land-based, new projects. For corporates, well you can find lower rated credits across industries.

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Return To Normal?

May 25th, 2021 by Kurt L. Smith

Vaccines are wonderful and it is great to get together with friends and family again. The feeling of hope and sharing good times are wonderful.

Last week we vacationed with the family in the mountains of North Carolina. Beautiful mountains, near the Appalachian Trail and, oh yeah, without any gasoline. Someone at the Colonial Pipeline thought it would be a good idea for a sixty-year-old pipeline to be on the internet. A group of Russian hackers looking to make an easy $5 million dollars agreed.

Before we left North Carolina we were re-routed off Interstate 40 in Memphis because the bridge across the Mississippi River was discovered to have quite a crack. I guess we were just lucky to make it across the bridge just a few days earlier on our way to the gasoline desert of North Carolina.

My February letter led off with the tragedy Texans faced losing electricity and later water service. While the cause was not Russian hackers, it might well have been. At least the Russian hackers apologized for their actions regarding the pipeline. Texans on the other hand, got to see their state legislature in action (yes, inaction).

Our infrastructure sucks. You do not have to be in the infrastructure business (like municipal bonds) to know this. We get to experience it…regularly. This is nothing new.  No one wants to be responsible and yet we are all responsible. We like to think we are immune here in Texas because so much of what we have is new: new highways, new airports, or at least terminals all over the state.  Yes, growth is better than the non-growth I see across the country but, as we experienced in February, we are not immune to infrastructure problems.  We are not even lucky.  Texas is a great place to be if you do not want to be responsible. Companies are moving here in droves as a result.

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An Ever Changing World

April 22nd, 2021 by Kurt L. Smith

High prices may be a time to celebrate, but they may also be a time for decision making. Nothing illustrates this better than the market for the U.S. Treasury bond bell whether trading at the highwater mark of highwater marks last year and losing all its gains since.

Last month we discussed the bellwether bond, the 2.375% of 2049 losing it’s 140 price premium, selling at a discount one year later in March 2021. For owners of this bond, it may be a case of easy come, easy go or we may hear “I bought it for the yield (seriously?)” as they continue to own the asset.

All owners of stocks should take notice. Gains do disappear, though stock investors also may take comfort in making the statement “I bought it for the yield” and continue to buy and hold. Everybody wanted to (and seemingly did) own General Electric, the darling of the 1980’s and 1990’s bull market, but then life happened, and it was not pretty.

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Should We Be Traders?

March 24th, 2021 by Kurt L. Smith

One year ago, I wrote my March 6th letter highlighting the risks of bond market investing when treasury securities all yielded less than 1%. It was a watershed moment and one I believed would be a reference point for years to come.

We have been following the bellwether treasury note and bonds as they continue to lose value as interest rates move higher. The ten-year note, 1.50% of 2/15/30, traded this past week below par at 98-22, down from 111-19 on March 9, 2020 or 11.5% lower (all prices from Bloomberg). The thirty-year bond, the 2.375% of 11/15/49 traded at a discount of 97-11+ versus 140-17 on March 9, for a 30.7% loss.

From a trading perspective, original buyers of these treasuries have watched their portfolio values surge and then come back to earth. A forty-point gain in the long bond is now wiped out. This is the nature of buying into a late-stage bull market. How high is high? Will you know it when you see it? Will you act or freeze?

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Be Prepared

February 24th, 2021 by Kurt L. Smith

The past week has been a tragedy down here in Texas. One crisis morphed into another leaving dozens dead and tens of billions in destruction. Simply terrible and preventable.

As a Texas native, ridiculously cold weather for a ridiculously long (for us) time is not a once in a century experience. Every decade or so it happens. But Texans are not all native Texans now (or ever). Texas has been growing by transplants forever and their expectations eventually collide with a horrible reality.

A gardener prepares his garden in the winter. A homeowner prepares her pipes before they freeze. An investor prepares for the downturn as the market moves higher. There is time for celebration but there is also time for work, the preparation what comes next.

Last month we focused on the ten-year Treasury note and long bond. Friday, February 19th, those sold at new low prices (high yields). The long Treasury bonds has now lost 35 points in value from March 9, 2020 at 140.17+ to 105.05+ Friday (all prices from Bloomberg). One of the recently sold ten-year Treasury notes, the .625% of August 15, 2030, has now lost more in price that it ever promised to pay investors in interest over its ten-year life, trading at 93.6875.

These treasuries are, of course, the favorite investment for the Federal Reserve Bank. Their appetite for all treasury securities has grown on their balance sheet from about $2.5 trillion a year ago to $4.8 trillion now (per Bloomberg). All the while, their price continues to fall.

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Bonds (Don’t) Move

January 20th, 2021 by Kurt L. Smith

Everyone can agree bond yields are low. Another way of saying that is, everyone can agree bond prices are high. But unlike the unhinged high prices of stocks, bonds are tethered to a maturity. The assumption of course being that the bond will be paid at time of maturity.

This risk of being paid (or not) is usually compared against what many consider to be the risk-free rate of US Treasury securities. Thus, Treasuries represent a non-credit risk option as they are assumed to be paid; the government will simply print more money to redeem them. All other (US) bonds do not have this feature of printing additional money; therefore, they are considered spread products.

As you know I recommended selling your bond products (mutual funds primarily), marking March 6th as the high-water mark for bonds. To say that March was a volatile month borders on understatement, but we witnessed US Treasury notes and bonds trade at their all-time highs in March.

The ten-year, Treasury note receives the most attention in the marketplace. For most of 2020 the note yielded less than 1%, again, a low yield in anyone’s book (and a high price). But recently the yield has moved over 1% leading to, well, the focus of this letter.

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Never Sell Anything

December 16th, 2020 by Kurt L. Smith

Years ago, and I mean many years ago, it became apparent that bond portfolio managers rarely sold bonds in their portfolio. Sure, active managers might sell something to keep their active manager label active, but rarely did a bond manager sell bonds in the portfolio to meaningfully move the needle on their holdings. If a manager did not like the market, she could enter a derivatives trade to place her bet instead.

Another reason for the never sell mentality in bonds was the fact that more money usually came in the door. When bonds perform well, investors tend to stick with it or even add funds. Combine all this with the other fact that bonds do mature, and bond portfolio managers are usually in the position of deciding where to invest cash rather than the prospect of selling bonds to raise more cash.

This has been the case for decades, though there may have been some managers slow in the 1980’s and early 1990’s to warm up to the fact that we were in what would become a multi-decade bond bull market. While the rise in the bond market has not been straight up, I would argue, from a portfolio management standpoint, it might as well have been. Bond portfolio managers have largely been reluctant to sell even prior to the large swoon in the financial crisis of 2007. If anything, the recovery since has largely reinforced the idea of never sell anything.

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Portfolio Construction

November 18th, 2020 by Kurt L. Smith

With the crescendo of all US Treasury yields to trading below 1% in early March marking the high-water mark for bond prices, the need to revisit how portfolios are constructed has emerged. Is the traditional 60% stocks/40% bond model dead?

This may indeed be a worthwhile question to explore but it is the underlying assumption or the underlying narrative of a stock/bond mix that warrants examination. For decades scholars of portfolio management theory ran studies after studies showing how a mix of assets, even as simple as stocks and bonds, can lower the risk and improve returns of non-diversified portfolios.

With the advent of computers in investing and something as relatively simple as a pie chart, investors could “see” how they were invested. When stocks swooned in 2000 and 2007, yes, diversification worked as advertised…just look at the results!

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The Market Doesn’t Care

October 20th, 2020 by Kurt L. Smith

Voting is in full swing across our nation and I am sure you will be voting as well if you haven’t already. While we all care about our election, the market does not.

In a world filled with varying narratives, not to mention conflicting narratives, narratives do not move markets. News, breaking or not, also does not move markets. Yet markets move, even in ways that may convince you that something, or someone (or several someone’s) may be responsible.

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We Are All Traders Now

September 23rd, 2020 by Kurt L. Smith

Over the past couple of months, we have witnessed what it is like to be winners. Investors of stocks and bonds have watched their portfolios move higher with interest rates at or near historic lows, bond prices are unbelievable high. And the effects of high bond prices have reverberated across asset classes.

I pick on bonds because they are “fixed income”. There is only so much income a bond generates (it’s coupon amount) and for only so long (it’s maturity). So, when interest rates are near zero, the price of the bond is approximately, or near, the sum of all of its cash flows (coupons plus maturity or par amount).

A 1% ten year noncallable bond that sold at 100, would be priced at 110 if interest rates moved to 0%. At .50%, the bond would be priced at approximately 105, still a nice 5% gain from no-or-low interest rates to even lower rates.

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NEWS FEED

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