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Stocks will keep on rising until they no longer do and with the jump start of January behind them, this may be the turning point.

The Great Wait May Be Over

February 11th, 2014 by Kurt L. Smith
  • The optimism, the good news, the earnings reports and everything else wonderful has culminated in the beautiful rise in stock prices.  Climbing the Wall of Worry?  There is no worry as this one way freight train moves only in one direction smashing all the remaining bears with it.

    There are more reasons today that stock prices should continue their one way ride than there were a year ago.  And oh what a year 2013 was for stocks!  But reason (and reasoning) has little to do with it.  Emotion, fear and greed, or mood, matters.

    Stocks may be the end-all but we have watched the other markets take a decidedly negative turn.  No market moves straight up and no market continues a trend (up or down) year after year after year.  Trends change.

    Trends change and they can change swiftly and such change can be hazardous to the economy, your world and your portfolio.  The primary reason I believe for swift change is because of the (heretofore) hidden effects of leverage.  In previous Market Letters I have discussed the preponderance of leverage and together with a high flying stock market bubble there may be an opportunity for historic volatility.

    I don’t have to tell you stock prices fall faster than they rise.  You remember 2008.  You remember 2000 and you remember 1987.  You may even remember me shying away from all things stocks as I believe and continue to believe stocks will retrace all of their gains since 2009.  So for all of those in stocks for the trade, remember to trade away.

    Mood moves markets and we have already witnessed historic turning points in Oil, Gold and Silver, Bonds and the US Dollar.  Stocks are the last to fall into place (pun intended).  I don’t know that December 31, 2013 is the final high for the Dow Jones Industrials, but if it is, then the Great Wait is over and a new era of volatility should emerge.

    Yes, this may be like Ground Hog Day.  After all it is February and Ground Hog Day is on Super Sunday no less.  Stocks will keep on rising until they no longer do and with the jump start of January behind them, this may be the turning point.

    Stocks matter because mood matters and mood matters even with the relatively tiny asset class of Municipal Bonds.  The trend in Bonds changed in 2012 and I marked Thanksgiving 2012 as the top of the Municipal Bond Market Bubble.  Bad for Municipal Bonds, right?

    Investors buy Municipal Bonds for yield as well as performance.  So while the performance of longer-term Municipal Bonds has wiped out several years worth of yield (as prices fell and performance suffered), yields are up.  Investors waiting for higher yields had their wishes granted and they have been investing lately in higher yields than those available in 2012.

    This is the ebb and flow of a marketplace.  But remember that 2013 was a period of an excellent, if not extreme, optimistic mood.  This optimistic mood carries into the Municipal Bond market as well.

    Risk in the Municipal Bond market?  Risk is easily discounted in Bonds with a strong “I believe these bonds will pay” proclamation.  In a strong optimistic mood period, one would expect a positive bias for all but the obviously weak links in the marketplace.  Everybody knew about Jefferson County, Detroit and Puerto Rico — that was obvious, right?

    Let me give you an example.  The Houston area owes much of its tremendous growth to municipal utility districts (MUDs).  In optimistic times MUDs are created, bonds are sold, homes and/or businesses built, assessed value is created, taxes are collected and bonds are repaid.  Whether a MUD is old or new, well managed or over leveraged, one cannot know merely by looking at the name of the district; one must investigate its credit quality.  But sometimes, particularly when times are good and optimistic, the assumption becomes that the bonds will pay because they always have in the past.  This is not the case when optimistic times become pessimistic as they did in late 2008 and the issuance of MUD bonds disappeared as did a lot of the liquidity for such bonds.

    By definition a defaulted bond only becomes defaulted after the fact.  Up until the day a default occurs all bonds belong to the incredibly huge and seemingly safe fraternity of the undefaulted.  It is my experience that a positive mood period tends to result in the good credit quality bond and the marginally good (or near bad) bond seemingly trading similarly.

    In my opinion, the volatility and weakness of June 2013 in the municipal bond market has finally corrected itself.  Municipal bond prices have slowly been improving since September but are largely unchanged from June.  Therefore I expect the next exciting leg of falling Municipal Bond prices to begin to unfold.  The buyers who waited for the June swoon have largely invested again.  They bought on weakness and they expect prices to continue to improve.  Like other markets, buyers on “the dips” is a great strategy as long as the trend is up; I believe up is over.  Thanksgiving 2012 was the turning point.

    In the Great Asset Bubble of the 21st century bubbles are now a popping.  Commodities peaked in 2008 and are now down over 40% since then.  Oil peaked then as well and is down over 30%.  Silver peaked in 2011 and is down 60% while Gold peaked a few months later and is now down 35%.  Long-term US Treasury bonds fell 25% from June 2012 into January 2014 and ten year US Treasury notes fell 11% (or almost 8 years worth of the 1.38% yield at the top).

    Stocks are indeed the last frontier.  For all of those who believe in “As January goes, so goes the year,” 2014 should be quite a year.  My expectation is for the increasingly positive mood of the past five years to reverse and the implications will be evident in stock prices but will also bode well for the municipal bond selection process of The Select ApproachTM.  We have waited patiently.  We have Cash we can put to work in selective short-term municipal bonds and hopefully our plans will continue to come together.

    Goose Creek Independent School District, TX
    Moody: Aaa (Aa2 Underlying) S&P: AAA (AA Underlying)
    Permanent School Fund Guaranteed
    DUE 2/15 DATED 3/1/14 MATURITY: 2/15/2030
    SALE AMOUNT: $18,330,000

    YEAR MATURITY COUPON YTM*
    1 2015 2.00% 0.25%
    2 2016 1.50% 0.35%
    3 2017 1.50% 0.56%
    4 2018 4.00% 0.91%
    5 2019 5.00% 1.22%
    6 2020 5.00% 1.65%
    7 2021 5.00% 2.02%
    8 2022 5.00% 2.34%
    9 2023 5.00% 2.56%
    10 2024** 5.00% 2.70%
    11 2025** 3.00% 3.08%
    12 2026** 3.00% 3.18%
    13 2027** 3.25% 3.40%
    14 2028** 3.50% 3.57%
    15 2029** 5.00% 3.32%
    16 2030** 5.00% 3.39%

    *Yield to Worst (Call or Maturity) **Par Call: 2/15/2024
    Source: Bloomberg
    This is an example of a new issue priced the week of 2/3/14
    Prices, yields and availability subject to change

     

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