The Madness of Crowds

Several weeks after my March 2020 letter calling the end of the multi decade bull market in bonds, the US treasury sold $22 billion in 1.25% treasury bonds due May 15^th, 2050, at a slight discount. In August 2020 those bonds sold at a slight premium and on October 21^st, 2022, the same bond sold at below fifty cents on the dollar (all prices per Bloomberg).

The crowd, rather than sell at the top in 2020, instead chose to buy. This is the madness of crowds. Since 2020 my experience in the marketplace tells me that few have chosen to sell bonds. Treasury bonds, like stocks, are priced based on the last trade. It does not take a large quantity of bonds to set a new price. It may not involve many trades at all. But now, a mere two years and two months later, 50% of the value of this bond has been wiped out.

In the annual running of the bulls (actual bulls versus the financial creature) in Pamplona Spain, the crowd can serve as protection. Bull markets are like that, as rising tides do float most ships, and after almost four decades of bull markets investors may be forgiven for not remembering what a bear market cycle looks like. In contrast, bear markets do not afford the crowd such protection and investors are likely to be gored as we have seen in buyers of the 2050 treasury bond.

Selection does matter, but more important is identifying a bear market. I was serious about my March 2020 letter, and I hope you received it as such. The multi-decade bond bull market (like all bull markets) was always going to end. We just did not know when. The reason I chose to specialize in municipal bonds is I saw a market that offered my clients a unique opportunity in both bull and bond bear markets.

I founded The Select Approach^TM on the principle that select municipal bonds could provide opportunities to double or triple or money and bull markets as well as perform in bear markets. Look at the bonds in your portfolio today and compare them with that long treasury bond. Selection is important.

This is not because municipal bonds are a special asset class. At roughly $4 trillion in issued value, municipals represent but a backwater of the $100 to $200 trillion in financial asset market assets depending on how and what you choose to count. Municipal bond funds including municipal bond ETFs (exchange traded funds) are down in price and down sharply though most are not quite down 50% like the long treasury bond.

This is why, in my March 2020 letter, I said to sell bonds. Whether actively managed or passively managed, it did not matter. Funds were exposed to the coming bear market and the results would probably not be good or something worth riding out.

Now we have a bear market across all asset classes. Stocks, bonds, commodities, real estate… it does not matter. In my opinion are all are subject to the same goring we have seen in the supposed risk-free treasury bond market.

Amazingly we have reached this point with very little selling. Some values seem to disappear a little at a time (like the treasury bonds) while other values may disappear in a 25% air pocket seemingly (or literally) overnight. It does not matter how; the result is the same: lower asset values.

This is the lesson: in a bear market, values disappear. Therefore, you should not own assets except those that are moving towards par and have the credit quality to mature. In a bear market, asset prices trend lower. There is no reason to own and nothing to ride out as there is technically no bottom to asset prices (except zero). This is the opposite of where we were at the beginning of the year (and for every year over the previous four decades). In a bull market there is no upward limit; but in a bear market there is, and the results of a bear market are not pretty.

In a bull market there is also an illusion of liquidity. Sure, there appears a willingness to buy back your assets at the prevailing market price in a bull market. But in a bear market such assumptions may only be assumptions. Finding yourself in a crowd as an investor you may have the ability to sell today as an individual, but if the crowd decides to sell, all bets towards liquidity may quickly disappear. One must act before the crowd.

Acting before the crowd is a hallmark of The Select Approach^TM. The reason I bid bonds is to bring you worthwhile value you would not see or be able to invest in. Whether in a bull market or a bear market, patience is required to find the select bonds. With few sellers through the years, filling orders could sometimes be difficult, but I hope you’re pleased with the results patience has provided.

In the coming months we may begin to see the selling I expect as investors experience losses of ten, twenty, thirty, forty or fifty percent. Just because the treasury bond is down 50% or the S&P 500 Index is down 20%, it does not mean we are in for a bounce. In a bear market, there are no the road maps except lower prices in the future.

After decades of the bull and even two-plus years of a bond bear, it appears to me old habits die hard. Buying the dips is a winning strategy in a bull market. Just look at the 4000 point rally in October in the Dow Jones Industrials – how smart! But imagine the crowd rush if/when investors determine the bounce does not have legs and the bull market in stocks is over. Hard to imagine? Anyone who bought thirty-year treasury bonds for 100 with the expectation of realizing about 138 (1.25% for thirty years plus principal) to be received over the next thirty years is now looking at about 50 cents on the dollar on their statements. The bear is here and the implication for investors is likewise grim. Following the crowd in a bear market can be quite costly, act.

City of Paris, TX

Waterworks and Sewer System Revenue Bonds, Series 2022

A1 Moody’s AGM Insured (A3 Moody’s Underlying)

Due 6/15   Dated 11/1/22 Maturity 6/15/51

$26,795,000 Sold

Years   Maturity           Coupon      Yield*

2         2024             5.00%           3.52%

3         2025             5.00%           3.60%

4         2026             5.00%           3.69%

5         2027             5.00%           3.74%

6         2028             5.00%           3.86%

7         2029             5.25%           3.93%

8         2030             5.25%           4.00%

9         2031             4.00%           4.08%

10          2032**       5.00%           4.19%

11          2033**       5.00%           4.30%

12          2034**        5.00%           4.47%

13          2035**        5.00%           4.60%

14          2036**        5.00%           4.65%

15          2037**        5.00%           4.72%

16          2038**       5.00%           4.81%

17          2039**       5.00%           4.90%

18          2040**       5.00%           4.96%

19          2041**       5.00%           5.01%

25          2051**       5.00%           5.24%

*Yield to Worst (Call or Maturity) ** Call 6/15/31

Source: Bloomberg

This is an example of a new issue priced the week of 10/24/22

Prices, yields and availability subject to change