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Relative highs are not the same as actual highs (which again, I date back to Thanksgiving 2012) but it should give pause as the current richness in longer-term municipal bond prices may mean a steep fall in prices as the downward trend in bond prices begins to take hold and become recognized.

Moving Ahead

August 3rd, 2017 by Kurt L. Smith
  • Narratives make great stories, coaxing investors to invest but rarely the impetus to sell.  Narratives, the stories about why the market is behaving this way or that, add fuels to the fire of salesmanship and lines up well for the growing herd, the multitude of trend followers. 

    The great narrative of the past few years has been yields are (and will forever be) low, so you should add riskier assets to your portfolio. This narrative has been in place so long ( for years) it appears it will never change.

    Our approach shows otherwise. In the incredibly unique world of municipal bond investing, opportunities have existed in high quality credits that are not available in any other asset class. In a world focused on scale, size, generic products and spread, the municipal bond market offers this as well as alternatives to this.

    We are in the nascent stages of a profound trend change in the bond markets. The pundits will continue with their “lower for longer” mantra for as long as they can, as it serves their interests. Lower yields mean higher prices; nobody wants (or likes) lower asset prices – that is in nobody’s interest. Unfortunately reality has other ideas. Markets, contrary to our most recent experience, also move lower. Sometimes markets move tremendously lower.

    The good news is we have practice and experience navigating a municipal bond market that would not appear to offer anything unique to other bond markets. A rising market does float all boats and I would agree municipals have been a beneficiary along with other financial asset classes.

    But the trend changed in 2012, to be exact, a long-time considering the “lower for longer” mantra that dominates the market. That is five years of a seemingly sideways market that began with many yields not only at cyclical lows, but at historical all-time lows. Yet we performed in this environment, without wading into so-called junk or lower rated municipals. We continued to practice our approach.

    This past week, generic ten year municipal bonds were priced at 81% of US Treasury bonds, a seven-plus year extreme according to Bloomberg. For managers of billions of dollars in municipals (the one’s focused on scale, size, generic-ness and spread), this means they have done quite wells for investors as municipal bond prices are at a seven year relative high.  Relative highs are not the same as actual highs (which again, I date back to Thanksgiving 2012) but it should give pause as the current richness in longer-term municipal bond prices may mean a steep fall in prices as the downward trend in bond prices begins to take hold and become recognized.

    Municipal bonds will be thrown out with the bathwater just like other bond asset classes as others begin to recognize the trend has changed. Recent predicted moves are not panning out for the pundits.  The markets were poised to move to higher bond prices in July, yet it did not happen. Our call for the next leg up is interest rates (and fall for bond prices) continues to point in the direction of the trend.

    We are prepared for the new trend as we have been working at it for the past five years. The recent focus since last July 2016 is to let you know sideways is over and prices will move in a quicker fashion (to the downside). This should particularly be true for the longer bond segment and the trend change should become more and more evident.

    We have witnessed the high water market for bond prices. Whether municipal, government, corporate or mortgage prices should slide and performance figures suffer. We are correcting thirty years of trend so it will not be pretty.

    It is not the common characteristics of municipal bonds that we seek. All bonds pay interest, have a maturity date and have a price/yield. Managers of billions (or trillions) of dollars in bonds utilize scale, size, generic-ness (same-ness) and spread to their advantage in a thirty year bull market for bonds. Now in a bear, there is no place those managers can hide. Bill Gross walked away from managing trillions of dollars in bonds he evidently couldn’t (ever) sell to focus on new securities in a relatively tiny new portfolio. We have stayed put to focus on the uniqueness available to us in the multi-faceted municipal bonds asset class.

    Plano Independent School District, Texas GO

    Moody’s Aaa (Aaa Under)  Standard & Poors AAA (AA+ Under)

    Permanent School Fund Guaranteed

    Due 2/15 Dated 8/1/17 Maturity: 2/15/2037

    Sale Amount: $108,020,000

    YEAR MATURITY COUPON YTM*
    1 2018 3.00% 0.80%
    2 2019 5.00% 0.88%
    3 2020 5.00% 0.98%
    4 2021 5.00% 1.08%
    5 2022 5.00% 1.18%
    6 2023 5.00% 1.31%
    7 2024 5.00% 1.47%
    8 2025 5.00% 1.64%
    9 2026 4.00% 1.81%
    10 2027 3.00% 1.97%
    11 2028** 3.00% 2.20%
    12 2029** 3.00% 2.40%
    13 2030** 3.00% 2.60%
    14 2031** 3.00% 2.80%
    15 2032** 3.00% 2.97%
    16 2033** 3.00% 3.08%
    17 2034** 3.00% 3.13%
    18 2035** 3.00% 3.15%
    19 2036** 3.00% 3.144%
    20 2037** 3.00% 3.138%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2027

    Source: Bloomberg

    This is an example of a new issue priced the week of 8/3/17

    Prices, yields and availability subject to change

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