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This utter sameness is not just a municipal bond market quality, it is an apt description of all financial markets of late. No wonder complacency is so thick.

No, It Won’t Be Like This Forever

February 11th, 2013 by Kurt L. Smith
  • Sure short-term interest rates are near zero; nothing new here.  But the good news, albeit great news, is we continue to find worthwhile, short-term municipal bonds.  In a world of generic, too-big-to-fail, debt by the billions, you can thank a very diverse, too-many-issuers-to-count municipal bond market for these opportunities.

    Asset prices continue at their elevated levels, supported by greater and greater debt levels.  The Federal Reserve’s own balance sheet topped $3 trillion last week.  With continued bond buying for their quantitative easing program in full force, the Fed’s balance sheet will soon equal the size of the $3.7 trillion municipal bond market.  The primary difference:  the Fed owns essentially one type of credit (US Government debt) whereas the municipal market contains myriad issues, issuers and credits.

    In a never-changing world, it doesn’t matter whether you own one credit or tens of thousands.  All debt is good debt in this static world.  This was the realization of the money management and financial community last year: low interest rates forever and low default rates forever.  Faced with this reality (merely a huge assumption), buying long-term bonds would be the obvious choice.

    This is why I argued last month that long-term municipal bonds are in a bubble.  Just like the uber-assumption that residential real estate only goes up in price, the assumption of low interest rates and no defaults has pushed long-term municipal bond prices into bubble territory.  To reach bubble status everyone must be a believer and this appears to me to be where we were at year-end 2012.

    You know we do not live in a never-changing world; quite the opposite.  The world is changing every day, new trends are developing and eventually others will see that, oh, the world DID change.

    From the majority vantage point, municipal bonds appear to look just like other bond markets.  Low yields and high prices dominate.  To measure what is “going on” in municipals, most merely look at the latest new issues coming to market.  Under the never-changing world assumption (low yields and no defaults), this week’s new issue market looks just like last week’s (this month’s like last month’s and this year’s like last year’s).

    This utter sameness is not just a municipal bond market quality, it is an apt description of all financial markets of late.  No wonder complacency is so thick.  This is the current narrative of Wall Street so why not reach for the highest yield you can find?  This is the logical path when there is such a broad assumption of a never-changing world.

    Thankfully there exists a market where change exists every day and this change is positive.  Each and every day that the bond market is open someone wants to sell some of their old municipal bonds.  I’m not talking months old municipal bonds; I am talking years old and preferably many years old.

    In this secondary municipal bond market I don’t have to worry about how many billions of dollars of municipal bonds are coming to market or not coming to market.  I don’t need billions of bonds because you don’t need billions of bonds.  What we do need are bonds that make sense and thankfully I am able to find bonds that fit what I am looking for.

    We owe this opportunities to the sheer diversity of the municipal bond credits.  The world speaks in terms of generalities; we seek specifics.  The world talks in terms of trillions and billions and we seek thousands and millions.  The world thinks big government is the answer and we seek opportunities in small municipalities.  The world is convinced little risk exists and we see risk everywhere, yet we like every bond we bid.

    I can’t create the ideal bond.  I can’t create any bond.  But I do know where to look for bonds and I do find worthwhile bonds for my clients, day in and day out.  As the utter sameness lulls everyone into a state of (seemingly forever) complacency, I expect, plan for and yes, even see change occurring every day.

    It won’t be like this forever.  Every day is a new day in the secondary “used” municipal bond market where we work and every day there are new bonds and new opportunities to keep our Cash working yet remain prepared for the dramatic changes ahead.

    Pasadena Independent School District, TX
    Moody: AAA (PSF Enhanced) Aa2 Under  S&P: AAA (PSF Enhanced) AA Under
    Permanent School Fund Guaranteed
    DUE 2/15 DATED 3/1/12 MATURITY: 2/15/2032
    SALE AMOUNT: $226,360,000

    .5 August 15, 2013 1.00% 0.17%
    1 2014 2.00% 0.19%
    2 2015 3.00% 0.40%
    3 2016 3.00% 0.61%
    4 2017 3.00% 0.76%
    5 2018 4.00% 0.92%
    6 2019 5.00% 1.18%
    7 2020 5.00% 1.40%
    8 2021 5.00% 1.63%
    9 2022 5.00% 1.81%
    10 2023 5.00% 2.00%
    11 2024** 5.00% 2.10%
    12 2025** 5.00% 2.19%
    13 2026** 5.00% 2.27%
    14 2027** 5.00% 2.35%
    15 2028** 5.00% 2.42%
    16 2029** 5.00% 2.48%
    17 2030** 5.00% 2.54%
    18 2031** 5.00% 2.59%
    18 2031** 4.00% 2.79%
    19 2032** 5.00% 2.64%
    19 2032** 3.00% 3.10%

    *Yield to Worst (Call or Maturity) **Par Call: 8/15/2023
    Source: Bloomberg
    This is an example of a new issue priced the week of 2/4/13
    Prices, yields and availability subject to change


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