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The coming crisis will involve the concepts of credit quality and leverage coming home to roost. I could add that this is the case with all crisis, but that would not be true.

Never Sexy

September 6th, 2018 by Kurt L. Smith
  • Another month, another summer. I hope your summer was worthwhile, mine certainly was. Usually things run slower during the summer months and again that was true in our little corner of the market. Yet, despite no one quite knowing how municipal bonds “work”, they continue to do so. For us anyway.

    While some stock indexes hit new all-time highs last month, that doesn’t equate to much change at all over the past six months. Some say the same thing about municipal bonds, even the ones I’ve found for them, but these folks are thinking short-term. I don’t deal in the latest, shiniest object. Nothing sexy here.

    Cash and cash alternatives are rarely sexy. Yet this is the asset class which I believe is rising in prominence and will continue to do so over the next number of years. It is also an area of expertise that not many people possess.

    Anyone can buy treasury bills, short-term notes and bonds and call it cash alternatives. Do it for as long as you want, then let’s compare your returns. Oh, you’ve come up with a new way to skin a cat…. again let’s compare returns.

    Yet it is not the returns over this period or that that is the big deal here. The big deal has always been credit. Who you are investing in is the deal and this is what makes us special. Our expertise lies in our selection. Selection makes the difference in quality as well as the difference in performance.

    Markets move like markets, that is they trend until they don’t. This is the reason why I felt comfortable calling the Bond Crash of 2018 (eight months no; four more to go). Markets do crash, changes happen and the bonds we select are done so with this mindset. Yet our bonds also perform, quite well, thank you, as you see each month in your statement.

    The Select ApproachTM works because it does not follow Wall Street norms. We do not buy what others buy; we can only buy what others sell. To do that consistently and to do it well, that is why it is expertise.

    Selecting good credits should be easy to do in good times. This is similar to saying that all bonds are good until the day they default. That is not credit analysis; that is the absence of credit analysis.

    The secret of the municipal bond market is that some credits are leveraged and some credits are not. This is not the case for every other fixed income market. There is no such thing as an under leveraged treasury bill or note, corporate bond or asset-backed security.

    Wall Street is all about scale. They create what is in demand and you cannot create under leveraged debt. New debt is by definition more debt. This isn’t to say that low leveraged issuers never sell debt; they do – they are just almost always municipal issuers.

    Higher returns involve higher risk. If you believe this then I suggest you stick with your day job. When it comes to municipal bonds and when it comes to credit, there is normal but there is also not normal. Why would anyone want to specialize or become expert in normal?

    The coming crisis will involve the concepts of credit quality and leverage coming home to roost. I could add that this is the case with all crisis, but that would not be true. Very little regarding credit quality and leverage came home to roost in the aftermath of 2008, which should make the next crisis even scarier. This is why cash, cash alternatives and the concepts of credit quality and leverage are so important today. This should be a larger and larger percentage of your portfolio going forward.

    While the rest of Wall Street is seemingly putting more and more eggs in the proverbial same basket (FAANG stocks anyone?), I believe you should be moving into the asset class for the future, cash. As a reader of this letter you already know that all cash is not created equal. Nor will it ever.


    Bay City ISD, Texas

    Standard & Poor AAA (A+ Under)

    Permanent School Fund Guaranteed

    Due 2/15 Dated 9/1/18 Maturity: 2/15/2049

    Sale Amount: $20,955,000

    1 2019 5.00% 1.56%
    2 2020 5.00% 1.68%
    3 2021 5.00% 1.82%
    4 2022 5.00% 1.95%
    5 2023 5.00% 2.07%
    6 2024 5.00% 2.19%
    7 2025 5.00% 2.31%
    8 2026 5.00% 2.44%
    9 2027 5.00% 2.53%
    10 2028 5.00% 2.61%
    11 2029** 5.00% 2.67%
    12 2030** 5.00% 2.75%
    13 2031** 3.00% 3.12%
    14 2032** 3.125% 3.25%
    15 2033** 3.125% 3.33%
    16 2034** 3.25% 3.40%
    17 2035** 3.25% 3.43%
    18 2036** 3.25% 3.46%
    19 2037** 3.375% 3.51%
    20 2038** 3.375% 3.53%
    21 2039** 3.375% 3.56%
    24 2042** 3.50% 3.59%
    27 2045** 3.50% 3.62%
    31 2049** 3.625% 3.71%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2028

    Source: Bloomberg

    This is an example of a new issue priced the week of 8/28/18

    Prices, yields and availability subject to change


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