Municipal Letter Newsletter Sign-up >>>


Some municipal bond issuers have deleveraged significantly over the past five years while a number of those municipalities issuing bonds over the past few years are indeed leveraging up. In other words, municipal bonds can be approached as the anti-generic asset class and that’s exactly how I have approached them

Any Further Than I Can Throw Them

January 30th, 2014 by Kurt L. Smith
  • Crippling debt is not a problem for companies, governments, municipalities or even individuals until the day it is a problem.  The power of greater leverage can be downright amazing and spectacular.  But when it comes to your money I no longer believe the risks associated with leveraged issuers are worth the reward.

    Two reasons I believe the risks are no longer worth it.  First, the world has changed: there is much more debt and many issuers are leveraged issuers.  Second, in the municipal bond market additional risks due to leverage doesn’t necessarily mean additional yield.  I like the corollary even better: sometimes lower risk bonds yield more and this is what I am looking for.

    The world has changed.  According to SIFMA, the U.S. Bond Market grew from was $20 to $27 Trillion in the 1990s and reached a record, just shy of $40 Trillion in 2010.  No matter how you cut it, this is significant debt, as well as significant growth in debt.  When you further compare this debt to the value of U.S. Stock Market as SIFMA does, you also see Stock Market values lower than their 1999 $28 Trillion peak.

    You see, the world has changed: there is significantly more debt.  This exponential explosion in debt isn’t just apparent in bond market assets, but it is apparent in just about every facet of economic life.  Government, led by the Federal Reserve and other central banks have ramped up debt levels tremendously.

    For many entities, the difference between then and now is often times “more debt.”  This makes the job of money managers more treacherous.  When Pimco’s Bill Gross decides to change his portfolio, it entails moving hundreds of billions of dollars, usually among one (more) leveraged asset like US Mortgages into other (more) leveraged assets like US Treasury notes and bonds,

    Such predicaments were not as great a problem prior to June 2012 as bond prices did nothing, seemingly, except go up in price.  That date marked the peak of the Golden Age of Bond Market Management.  Buy long, buy anything and the bond market would make you look like a hero.  Those were the days of no worries; today is a different day.

    Municipal Bonds have such a cornucopia of offerings that higher risks don’t always mean higher yields (yuck) but also that lower risks can mean higher yields (yeah!).  With tens of thousands of different credits and tens of thousands of different terms together with the municipal markets tendency to offer (many) serial bonds of varying maturities versus other issuers tendency to offer (few) term bonds, municipal bonds look like a fragmented, disjointed market compared to the behemoths of government, corporate and mortgage bonds.  I believe this makes Municipal Bonds an excellent alternative to the (usually) over-leveraged world of government, corporate and mortgage bonds.

    Every US Treasury note is as leveraged as every other US Treasury note.  Additionally, this leverage has also only gone one way recently: higher.  This is not true for every municipal bond.  Some municipal bond issuers have deleveraged significantly over the past five years while a number of those municipalities issuing bonds over the past few years are indeed leveraging up.  In other words, municipal bonds can be approached as the anti-generic asset class and that’s exactly how I have approached them for the past ten years as I saw the debt explosion unfolding.

    I don’t trust municipal bond issuers any further than I can throw them.  This has been my guide for the past ten years and I believe it has served us well.  We began selling our long-term municipals ten years ago, before municipal bond insurance blew up and prices plunged to unthinkable levels.  We also found municipal bonds which worked for us rather than plow back into the bond market frenzy that bubbled to a top in 2012.

    Holders of long-term bonds have quickly discovered how far and how fast prices can fall on their bonds.  I believe this is only the beginning (owners of Gold have seen bad become worse) and I also believe the bond market experience of peak, plunge, rebound, (greater) plunge will follow for Stocks.

    “No brainer” investment strategies have a way of biting back.  Just ask the Gold bugs who have watched $1900+ become less than $1200.  Just watch Bill Gross try and discover where safety lies, let alone where the next bond opportunity may lie.  But none of these problems will compare to the greatest “no brainer” investment strategy of our lifetime: Stocks.

    What makes Municipal Bonds worthwhile is their ability to offer us safety that is unavailable in other generic asset classes.  Some quote that only 30% of bonds defaulted in the Depression which leaves 70% surviving but it doesn’t account for struggles.  Luckily for us, municipal bonds can be quite unique and their credit quality can likewise be unique (from defaulted junk to stellar credit and all in between).

    Usually not trusting a bond any further than I can throw it means shorter bonds.  Things can and do change quickly.  But every now and then I also come across municipal bonds which offer a level of security that even I like and for a longer period of time.  And sometimes that bond will also yield more rather than less, which is why I love this job.

    Odds are you are not a Gold bug that experienced a down 27% year.  Things are not that bad but I am preparing for bad nevertheless.  But I want you to know municipal bonds, the municipal bonds of The Select ApproachTM, can offer safety and worthwhile return even as the current flesh wounds in our market become worse and worse.

    Unlike Stocks and Commodities like Gold, Oil and Real Estate, the municipal bonds of The Select ApproachTM are selected based on what we believe to be their ongoing strengths.  We do not assume someday you must sell in order to realize a return; we assume you hold.  By finding worthwhile municipals that we can trust only as far as we can throw, we hope to not only weather the coming storm but also profit from it in ways not available in other asset classes.

    Midland Independent School District, TX
    Moody: Aaa (Aa2 Underlying) S&P: AAA (AA Underlying)
    Permanent School Fund Guaranteed
    DUE 2/15 DATED 1/15/14 MATURITY: 2/15/2040
    SALE AMOUNT: $85,235,000

    2 2016 3.00% 0.35%
    3 2017 3.00% 0.56%
    4 2018 4.00% 0.90%
    5 2019 4.00% 1.20%
    6 2020 5.00% 1.64%
    7 2021 5.00% 2.00%
    8 2022 5.00% 2.29%
    9 2023 5.00% 2.51%
    10 2024** 5.00% 2.66%
    11 2025** 4.00% 2.93%
    12 2026** 4.00% 3.08%
    13 2027** 5.00% 3.09%
    14 2028** 5.00% 3.19%
    15 2029** 5.00% 3.29%
    16 2030** 5.00% 3.37%
    17 2031** 5.00% 3.40%
    18 2032** 5.00% 3.48%
    19 2033** 5.00% 3.56%
    20 2034** 5.00% 3.61%
    23 2037** 5.00% 3.84
    26 2040** 5.00% 3.95%

    *Yield to Worst (Call or Maturity) **Par Call: 2/15/2023
    Source: Bloomberg
    This is an example of a new issue priced the week of 1/27/14
    Prices, yields and availability subject to change


    The $247 trillion global debt bomb…