Bears Out The Problem

Trend reversals take time with long term trends taking a long time to reverse. Throughout the multi-decade stock and bond bull markets we were used to trend reversals. By the time a downward trend was recognized, the odds were the correction was nearing its end and prices began to rise again. You might know this as buying the dips. It worked well for both stocks and bonds following the corrections of 2000, 2008 and 2020. But bonds failed to continue their bull ways while stocks went on to set new highs since then.

Bonds reversed trend in March 2020 almost five years to the day. We have entered a bond bear market, and you know it largely because I remind you every so often. Investors bought bonds on the dip in 2020, including you. Other investors invest in the bond market. Here at The Select Approach^TM, we rely on individual bonds to perform differently from the market.

Rather than selling one’s bonds in 2020 investors continued to buy because they were accustomed to buying dips. Even when the bond market failed to reach new highs in price, investors seemed pleased to buy cheaper bonds at yields much higher than in 2020. Buy more in a bear market? That is the power of Wall Street. That is the power of optimism. That is the power of not knowing the power of a bear market.

Of course, it may also be that investors do not really know how bonds work. Last month I discussed how individuals now own about seventy percent or $3 trillion of the $4.2 trillion municipal market. In a February 12^th Bloomberg article, author Martin Z. Braun looked at the returns (after fees) of open-end municipal bond mutual funds compared to customized portfolios known as Separately Managed Accounts (SMAs). Long national municipal open-ended mutual funds delivered 2.25%, -1.01%, 0.83% and 2.21% for one year, three-year, five-year and ten-year respectively. Looking at the performance of long national municipal separate managed accounts (SMAs), those clocked in with 0.58%, -1.35%, 0.47% and 2.13% for the same respective periods.

Several things stand out. First it seems amazing that five-year returns were even positive. But given the lack of performance it would not seem to engender much for additional investments. That has not been the case as the article also discussed how billions have flowed into the municipal market ($23 billion for the funds and $70 billion for the SMAs in the first three quarters of 2024 according to Morningstar).

Second, as we have discussed in recent letters, investors in municipal bonds are largely invested in the bond market itself, rather than in something special or different. Perhaps they are over the short term: how does one account for a 2.25% result versus a .58% result over one year? But generally, investing om the municipal bond market means owning the market. The same bonds yield similar results whether you are investing thousands in an open-ended fund or billions in SMAs. Your performance will tend to be similar. I call this the scale problem. In bond investing, Wall Street bond managers must invest in scale, buying bonds in large quantities to satisfy the demand of reinvesting coupon income, bond maturities, as well as keeping up with growth.

Over the past five years long term municipal bond investors have bought 2% bonds. Then they were able to buy 3% bonds and now they can buy 4% bonds. More yield, more better? Yes, if you assume such an opportunity is the equivalent of buying the dips. But that has not been the experience for bond buyers of late. The plunge in long-term bond prices has not rebounded as it did with stocks. The pitiful performance results above bears out the problem: a change in the long-term trend for bond prices.

The long-term trend for the bond market is toward higher yields and lower prices. That does not mean bond prices will not rally. We have talked about bond price corrections for many months in these letters. It was a correction that allowed billions to be invested in municipal bonds over the first three quarters of 2024 only to have much of the performance gains disappear in the fourth quarter.

As of today, March 3^rd, we saw the ten-year US treasury note trade at 4.10% (prices and yields per Bloomberg), a significant decline from 4.80% just a few weeks ago on January 14^th. Meaningful? Yes for trading in particular, but no, short-term corrections are how interest rates go from A to B. By the time a trend is recognized (even in this short seven week one), the odds are it is probably near its end. A trend, why yes, it appears to be…and therefore we should be seeing higher interest rates soon.

El Paso, TX

Water & Sewer Revenue Refunding Bonds, Series 2025

AA Underlying S&P         AA+ Underlying Fitch

Due 3/1   Dated 4/1/25 Maturity 3/1/50

$296,805,000 Sold

Years   Maturity       Coupon        Yield*

1         2026             5.00%           2.64%

2         2027             5.00%           2.65%

3         2028             5.00%           2.72%

4         2029             5.00%           2.77%

5         2030             5.00%           2.79%

6         2031             5.00%           2.84%

7         2032             5.00%           2.91%

8         2033             5.00%          2.99%

9         2034             5.00%          3.04%

10       2035**          5.00%          3.12%

11       2036**          5.00%          3.20%

12       2037**          5.00%          3.24%

13       2038**          5.00%          3.34%

14       2039**          5.00%          3.42%

15       2040**          5.00%          3.50%

16       2041**          5.00%          3.62%

17       2042**          5.00%          3.74%

18       2043**          5.00%          3.83%

19       2044**          5.00%          3.91%

20       2045**          4.00%          3.99%

20       2046**          4.00%          4.09%

20       2050**          4.00%          4.37%

20       2050**          5.25%          4.17%

*Yield to Worst (Call or Maturity) **Callable 3/1/34

Source: Bloomberg

This is an example of a new issue priced the week of 3/3/25

Prices, yields and availability subject to change