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Archive for the ‘Municipal Market Letter’ Category

Still Zig Zagging Away

June 3rd, 2023 by Kurt L. Smith

According to Bloomberg’s Nic Querolo, municipal bonds lost 1.38% for the month through late May, which would make it the worst May performance since 1986’s 1.63% loss. Querolo goes on to say May has been the strongest month for municipal performance over the past ten years at up .9% on average.

While I place the beginning of the bond bear market in March 2020, municipal bonds did not peak until August 4, 2021, per Bloomberg, selling off into the first leg of the bear market October 26, 2022 with a 13.4% decline in the Bloomberg Municipal Bond Total Return Index.

The correction since late September/early October has occurred for many, if not all, asset classes, municipals included. It was the correction’s peak in April that set up municipal bonds dreadful May.

We are still in correction territory and unfortunately (for traders), that is a tough place to be. February was a dreadful month for municipals as well but the bond market’s response to the bank failures in early March sent prices to new correction highs (new yield lows). Will we see another move to new correction price highs or is a tough May the precursor of higher yields yet to come?


Zig Zagging Away

April 27th, 2023 by Kurt L. Smith

As discussed last month, the correction continues. Stocks are trading about the same as where they were five months ago. Bonds are mostly higher, but the last three months have been volatile. Bottom-line, corrective periods such as these usually resolve in the direction of trend.

Volatility in bonds, as measured by the ICE BofA Move Index (all prices sourced from Bloomberg), showed the most volatility since the bear market began in 2020. The recent volatility began as the two-year treasury note yield bottomed in early February at 4.03%, spiking to over 5% on March 8th just as the news of the troubles of the Silicon Valley Bank began to hit. A wicked reversal ensued, with yields bottoming at 3.55% just a couple of weeks later March 24th. With two-year yields moving from .10% on January 5th, 2021, per Bloomberg’s Generic Two-Year Index, to 5.07% on March 8th, 2023, one might have expected a correction. So far, we have seen 3.55% on March 24th.

Looking at longer bonds, where price fluctuation matters, the correction on the US Treasury bond future began with a low October 24th, 2022 at 117-19 with a correction high of 134-14 on April 6th, a rise of about fifteen percent. The contract had closed within 2% of this high on four earlier occasions since mid-December, pulling back each time.

This bouncing back near its high pattern is like what we have seen in stocks: a market seemingly going nowhere. What we have been doing is marking time. As investors experiencing a bull market for many decades, marking time has been acceptable because the trend was upward in the bull market.

Now that we are solidly in a bear market pattern, marking time is an opportunity to evaluate where you are as the next move usually resolves with the trend. As with any correction, the question becomes when? We may not remember how awful stock market performance was back last October, but then bang, the correction started. This, unfortunately, is usually how it ends as well. Be prepared.


Bond Portfolio Blunders

April 3rd, 2023 by Kurt L. Smith

It is hard to fathom a $42 billion run on a bank. In one day, no less (source: State of California). One thing for sure, the dollars are bigger now. No longer do you need to stand in line to get your money from your bank. Zap, you can move it. Bang, the doors of the bank are shut. Just another day (or weekend) in our financial life.

Silicon Valley Bank (SVB-NYSE) did what any rational investor would do, realizing the bond market was in a bear. It sold. Not at the bottom in October, but in March, during the bond bear market correction. As I have said on these pages, a correction, particularly the end of a correction, is a good time to sell.

SVB had a plan and it hired Goldman Sachs to help implement it (source: Rueters). Sell $24 billion in bonds, mostly U.S. Treasury securities, for $21.45 billion. Considering 2022 was the worst year for bond market performance in the history of history, the losses could have been much worse. Goldman also advised the bank on a $2.25 billion capital raise to replace the bond loss. A prudent plan, it sure appeared.

No bank can survive a run on its deposits. Prudently run bank or otherwise, a bank run leads to a closed bank. So that is what the state of California did. The bank was closed. Now what?


Bear Market Reasserts Itself

February 28th, 2023 by Kurt L. Smith

Last month’s letter posited the correction in both stock and bond markets was over. The price action in February has indicated that to be the case.

Investors piled into both markets to begin the year; they have hope on their side. The bond market correction in two-year US treasury notes took it from 4.80% on November 4th to 4.03% on January 19th (all yields per Bloomberg). On February 24th the note traded at 4.84%, a complete reversal of the correction.

The ten-year US treasury note traded at a multi-year high of 4.33% on October 21, 2022, beginning it correction. Three months later it was 3.32% on January 19th when the correction ended, jumping to 3.98% on February 27th. While not as a dramatic reversal as the two-year note, the ten-year note has traded at a higher yield levels in fifteen of the last seventeen trading days through February 27th.


Correction Over

January 30th, 2023 by Kurt L. Smith

Yes, the correction in both stocks and bonds is now over. For the past forty-or-so years that would have been a good thing. But in a bear market, the end of a correction should be foreboding as the trend to lower prices reasserts itself.

As in the past several years, U.S. treasury bonds are taking the leadership position. After many months of weakness in 2021 and 2022, the correction in bonds began in November as treasury prices across all maturities began to rally. Oftentimes, corrections in a bear market can seemingly occur on a dime and suddenly thrust prices higher. The correction lasted until the middle of January and now the bear trend should reassert itself.

It is the municipal market, of all places, where we can see the correction at its fullest. Last year was among the worst ever for bond market performance but even horrible markets correct. Beginning in mid-November, prices on treasuries leapt upwards and yields, which had been moving higher, suddenly plunged lower.

Municipal bonds are a spread product. Investors buy them because the tax exemption gives them a higher net yield after taxes. So, it would make sense that municipal bonds would rally in the correction like the prices of US treasury securities.


Not Matching Expectations

December 20th, 2022 by Kurt L. Smith

In the hustle and bustle of the season, we would expect no less in a bull, bull, bull world. Our experience matches our expectations. Such is not the case with the financial markets.

While we are a couple weeks away from posting final 2022 results, the bull, bull, bull world has failed to deliver results. Depending on your yardstick of choice, you might categorize the results as poor, bad, or even horrific. Yet we cannot blame investors for not trying: the rally in both stocks and bonds from October to early December appeared to have legs…until it did not.

There is a reason for this expectation/performance mismatch, and it is not inflation. The reason is the bull market is over. And while stock investors may continue to believe they have seen this movie before, bond investors are surprisingly acting the same way.

Nowhere is the bull, bull, bull world more apparent than in the world of bonds. One example is in spreads. In writing about the treasury market, Jeff Sommer at the New York Times says “this has been an awful year for U.S. bonds — so bad that 2022 may end up as the worst calendar year in history.” Maybe that explains how Idaho Housing sold its 4.384% taxable municipal at 11 basis points below treasury yields (higher priced) last week (per Bloomberg). The bond is not a treasury! Idaho Housing bonds due six months later sold to the spread of seven basis points. Yeehaw! A lack of spread to treasuries is very bull, bull, bull.


It’s A Bull, Bull, Bull World

November 30th, 2022 by Kurt L. Smith

After forty years of bull market in financial assets, one can only imagine how difficult a change in trend may be to recognize. We live in a bull market world, enjoy the bull market experience and we have been doing so, for so long, we believe it is just the way things are.

The bull market has existed for both stocks and bonds for decades. Rather than serve to diversify one’s portfolio, stocks and bonds have been in a tortoise/hare race to the top. Unlimited optimism, or even abundant optimism, can only push bond prices so high, but for stocks, truly the sky was the limit.

So, it might make sense that the bond market might be the first to signal the bull market is over. The bond market performance story for 2022 has not yet been fully written, but unprecedented, the word used in these letters over the past several months, will surely be included.

Yet despite a treasury bond trading at half its value over a two-plus-year span, you would think investors would recognize this as a bond bear market. Staring at not only the worst bond market return in decades, but perhaps ever, we saw bond prices soar in November with Bloomberg saying last week “municipal bonds are having their best month in almost four decades.”


The Madness of Crowds

November 4th, 2022 by Kurt L. Smith

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 15th, 2050, at a slight discount. In August 2020 those bonds sold at a slight premium and on October 21st, 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.


The Need To Think Differently

September 27th, 2022 by Kurt L. Smith

We have discussed extensively characterizing this financial market as unprecedented. The bull market for bonds ended in March 2020 and all that was left was for stocks to finish their bull market run as well. This happened at the beginning of this year as we began to see unprecedented market moves in February 2022.

It is not surprising that last year was one for the ages for asset prices. One did not need to believe the bond bull market was over to enjoy a nice run up in private equity investments. Interest rates were still incredibly low allowing private equity, or leveraged equity, to trounce the performance of other asset classes. The S&P Listed Private Equity Index began 2021 at 168, hitting a high of 240 in November 2021 (per Bloomberg).

The bond bull market is over, and this is where you need to think differently. First and foremost is the lost ability to sell at worthwhile prices. Those private equity investments that performed so well in 2021, well, let’s just say they’re giving it all back in 2022 as the S&P Listed Private Equity Index recently printed below 150.

What about those other inflation fighting alternative investments? Real estate investments do not work as well with higher interest rates. Good thing you locked your rate in…except that will not help the investors you would like to sell to. In a bond bear market liquidity tends to go poof, sometimes overnight.

Bitcoin, gold, and even oil has seen their gains of last year reverse almost entirely. If you are beginning to think there is no place to hide you would be thinking in the right direction.


Sideways Over…What Is Next?

August 26th, 2022 by Kurt L. Smith

The sideways moves in financial markets these past few months has provided a respite from the unprecedented moves experienced in the first half of this year. A sideways move, also known as a correction, can confound market participants particularly traders and speculators who are generally trend followers.

Bond watchers should know the trend by now as bellwether interest rates on the ten-year U.S. Treasury note climbed from a low of 0.31% on March 9th, 2020 (prices/yields per Bloomberg) to 3.50% on June 14th, 2022. Those yields equate to a price of 111-19 in 2020 on the ten-year 1.50% U.S. treasury note due February 15, 2030, and 86-14 in June, for a loss of over 25 points.

The summer sideways action saw bond prices rally with the bellwether treasury note trading at 93-03 on August 2nd or 2.50% for a nice, quick one hundred basis point correction over about six weeks for a six-plus point gain…but now sideways is over. This week the yield on the ten-year note is now back over 3% (3.11% as of August 25th).

The trading action of the bellwether ten-year note is instructive because this is how corrections work. Yes, the 3.50% level in June was a new high for the cycle but it also a new high dating back 11 years! The ensuing correction was swift (so far, a matter of weeks), but it does not change the trend.

The current question for bonds is whether the correction (sideways action) continues for a few more months or whether bonds hit new higher interest rates (new lower prices) in the coming weeks.



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