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When markets turn, I should say, as markets turn, the more important question for investors is where they should invest. This is why I continue to emphasize the trends of the market.

Thankfully, We Own Municipals

May 4th, 2018 by Kurt L. Smith
  • Three percent ten year US Treasury notes have generated recent buzz with the highest interest rates in over four years. More interesting may be the yield on two year treasury notes at over 2.50%, the highest yield in over nine years.

    Lower for longer? This mantra for investing in both bonds and stocks has blown up. Interest rates are not lower and haven’t been lower for many years. My job is not to convince believers of the mantra that they have it wrong. Besides, despite rising interest rates, performance figures haven’t changed appreciably one way or the other. We continue to move forward with our approach.

    Our municipal bond market is a relatively puny player in the world of financial assets. With $3.8 trillion outstanding in municipal bonds, municipals make up a small portion of the $40 trillion US bond market (SIFMA). Black Rock and Vanguard each manage more financial assets than the entire municipal bond market.

    In the scheme of things, municipals do not matter. In the great buildup of the $40 trillion US bond market, municipals have become but a rounding error or an opportunity for diversification, whether warranted or not.

    Back in 1980, municipals totaled about $400 billion out of the mere $2 trillion US bond market, or about twenty percent of the bond market versus today’s share of less than ten percent. Municipals have grown 10X while the US bond market has grown 20X.

    When asset prices are rising and more assets are being created (i.e. the last thirty-plus years), scalability is key. The ability to grow markets 10X or 20X and capture those assets (money management) depends on scalability, becoming more efficient in the business of asset gathering and management. With over $4 trillion in assets under management, both Black Rock and Vanguard must be very efficient in gathering assets as well as investing in them. For those behemoths, a billion dollars is truly a rounding error, heck, so is $10 billion.

    We as investors care about efficiency and scalability when it benefits us. In a bull market, such efficiencies equate to greater returns. Greater efficiencies allow Black Rock and Vanguard to lower fees, hence increasing investment returns. Such scalability efficiencies have led to higher returns and provide a driver for their incredible growth.

    When markets turn, I should say, as markets turn, the more important question for investors is where they should invest. This is why I continue to emphasize the trends of the market. Higher yields across bond markets mean lower prices for bonds and lower returns, perhaps negative returns, for investors in longer term bonds or fixed income products. This is a reversal of a thirty-plus year trend and I do not expect the new trend of higher rates to be short lived either.

    In a world of trillions of dollars outstanding in US bonds and the fact that rising yields depress bond prices, one might think that investing in bonds is just not worthwhile. Our experience over the past several years tells us otherwise. This is the power of our little corner of the bond market: municipal bonds.

    Even though two year yields are at nine year highs and ten year yields are at four year highs, market participants continue to argue as to what this means. Performance-wise, bonds have yet to mark substantial new territory either positive or negative, that would sway many investors to change their particular current outlook. However, this too will change, because markets are rarely this stable for this long.

    Municipal bonds as ten percent of the US bond market do not, in general, offer anything unique in their potential performance as a bond. Higher yields mean lower prices; the longer the bond, the greater the potential for loss. A bond is a bond is a bond.

    However, within the municipal bond market exists unique opportunities not found in any other class of bonds. This is the area you have experience with; this is The Select ApproachTM.

    As bonds continue to weaken, as performance continues to suffer, as changes to stock markets occur, as commodity prices change, remember this: everyone needs to invest where one is most comfortable. Safety will become in vogue again, especially when the term “nowhere to hide” begins to surface again. Remember your municipal bonds!

    As accustomed as we all have become to high(er) asset prices, market forces have always controlled these prices. There is nothing that prevents crushing price declines for any or all asset classes or stores of wealth.  But unlike other asset classes, bonds mature at a fixed price. Our job is to find bonds that will mature (not default) and will mature in a timely manner (short term) to allow us to invest in higher return bonds down the ever exciting road.

     

    Huntsville, Texas Water & Wastewater Revenue

    Standard & Poor AA- Fitch AA

    Due 8/15 Dated 6/5/18 Maturity: 8/15/2043

    Sale Amount: $45,840,000

    YEAR MATURITY COUPON YTM*
    1 2019 5.00% 1.75%
    2 2020 5.00% 1.92%
    3 2021 5.00% 2.08%
    4 2022 5.00% 2.21%
    5 2023 5.00% 2.35%
    6 2024 5.00% 2.45%
    7 2025 5.00% 2.53%
    8 2026 5.00% 2.62%
    9 2027 5.00% 2.69%
    10 2028 5.00% 2.75%
    11 2029** 4.00% 2.84%
    12 2030** 4.00% 2.90%
    13 2031** 3.125% 3.31%
    14 2032** 3.25% 3.39%
    15 2033** 3.375% 3.48%
    16 2034** 3.50% 3.58%
    17 2035** 3.50% 3.62%
    18 2036** 3.50% 3.64%
    19 2037** 3.50% 3.68%
    20 2038** 3.50% 3.70%
    21 2039** 3.625% 3.74%
    23 2041** 3.625% 3.76%
    25 2043** 3.625% 3.78%

      *Yield to Worst (Call or Maturity) **Par Call: 8/15/2028

    Source: Bloomberg

    This is an example of a new issue priced the week of 5/1/18

    Prices, yields and availability subject to change

     

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