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One side effect of the optimism is how well marginal credit quality bonds trade. Insured, junk-rated municipals trade similarly to non-junk-rated municipals.

“Welcome To The Everything Boom”

July 20th, 2014 by Kurt L. Smith
  • The July Letter almost didn’t make it as the same old, same old markets continued their gravity defying ways. On July 7th however, The New York Times saw fit to publish this headline as their front-page lead: “From Stocks to Farmland, All’s Booming, or Bubbling.”

    “Welcome to the Everything Boom — and quite possibly, the Everything Bubble.” Evidently my feeling of once again discussing high asset prices would bore you, dear reader, to tears, was not a feeling shared by the powers that be at The New York Times. High prices, again?!

    The upshot of the article was that it is difficult to find cheap asset classes to invest in. By almost all historical standards, stocks are not cheap, commercial real estate is not cheap, commodities are not cheap nor are bonds cheap, particularly junk bonds. So what is an investor to do?

    We feel assets are expensive. We are optimistic that our plans (dreams) will come true and this optimism has driven stock prices to appear as if they will only go higher. Stocks are the asset class where expectations exceed almost all others and they are also the asset class that hasn’t rolled over since the Financial Crisis.

    Commodity prices, as evidenced by the CRB Index, peaked in July 2008, as did Oil at $147/barrel. Gold peaked at $1921/ounce in December 2010 with Copper following in February 2011 and Silver at just under $50/ounce in April 2011.  More significantly for us as bond investors, my previous Letters have noted how US Treasury notes and bonds peaked (lowest yield) in July 2012 with Corporate bonds peaking later in October 2012 and Municipal Thanksgiving 2012.

    But it is the tremendous optimism that continues to levitate Stocks. While other asset classes have peaked and begun downward trends, Stocks stand alone atop the investment heap. This is what made The New York Times story their front right piece.

    With ten year US Treasury note yields bottoming at 1.38%, yields are about double that today. As the ten year treasury serving as the benchmark for so many other types of bonds such as mortgages, corporates and municipals, one can certainly say something has changed. Yet compared to the relentless move of Stocks, nothing else seems to matter.

    While long-term municipal bonds remain cheaper than their Thanksgiving 2012 high, the optimism that propels Stocks does, in my opinion, make opportunities in municipal bonds more difficult. Unless you happen to own a bond with a similar sounding name as the current distressed bond de jour (Jefferson County, Detroit, San Bernardino, Stockton and now Puerto Rico), odds are you are quite comfortable and confident your bond will deliver as promised.

    Pervasive optimism has stoked complacency in much of the investment world and municipal bonds are no exception. Not only has trading slowed but so has new issue volume. This situation has the feel of throwing a piece of meat toward hungry piranhas: new issues are scooped up quickly, at lower margins for dealers while secondary market trades are fewer as well.

    One side effect of the optimism is how well marginal credit quality bonds trade. Insured, junk-rated municipals trade similarly to non-junk-rated municipals. Unfortunately, a large part of my job each day is wading through the lower-rated municipal bonds in my search for quality municipal bonds. Perhaps we are being rewarded for sifting through the detritus in our hunt for value and quality.

    Unfortunately value, quality and size does not appear to currently exist in the municipal bond market. Again, I blame the optimism, the complacency, and the overall lack of meaningful change for drying up the trading volumes in our municipal market. The bigger the size, the fewer the trades and the closer to the new issue yields (see the Dickinson TX ISD scale below). This situation is definitely New York Times-worthy of inclusion in a lead story. As a consequence, my institutional accounts are seeing less and less product from me.

    There is light at the end of the tunnel and as the New York Times story alludes to, it possibly is a train. As I said last month, the long-term trend for bonds changed in 2012 and I expect to see higher rates…(hopefully) soon. Whether higher rates dents the optimism and Stocks levitation or vice-versa, I do not know. But this is a market and things do change and as I hope I have demonstrated, things have changed. Yet against the relentless march of Stocks — who notices and who cares?

    I notice, I do care and I was happily surprised to see that The New York Times cares and obviously thinks you should care as well. Just remember: if the Federal Reserve was as all-powerful and so-in-control as today’s optimistic fervor believes, we never would have had the Financial Crisis. But now, in the Everything Bubble, we best enjoy it while we have it and prepare for its inevitable end.

    Dickinson Independent School District, TX
    Moody’s Aaa (A1 Underlying) S&P: AAA (A Underlying)
    Permanent School Fund Guaranteed DUE 2/15 DATED 8/1/14 MATURITY: 2/15/2044
    SALE AMOUNT: $56,000,000
    2 2016 5.00% 0.22%
    3 2017 5.00% 0.50%
    4 2018 5.00% 0.86%
    5 2019 5.00% 1.23%
    6 2020 5.00% 1.57%
    7 2021 5.00% 1.85%
    8 2022 5.00% 2.08%
    9 2023 5.00% 2.30%
    10 2024 4.00% 2.48%
    11 2025** 4.00% 2.66%
    12 2026** 4.00% 2.81%
    13 2027** 4.00% 3.00%
    14 2028** 4.00% 3.23%
    15 2029** 4.00% 3.31%
    16 2030** 4.00% 3.38%
    17 2031** 4.00% 3.45%
    18 2032** 4.00% 3.51%
    19 2033** 4.00% 3.57%
    20 2034** 4.00% 3.62%
    21 2035** 4.00% 3.67%
    22 2036** 4.00% 3.72%
    23 2037** 4.00% 3.77%
    24 2038** 4.00% 3.81%
    27 2041** 4.00% 3.87%
    30 2044** 4.00% 3.90%
    *Yield to Worst (Call or Maturity) **Par Call: 2/15/2024
    Source: Bloomberg
    This is an example of a new issue priced the week of 7/15/14
    Prices, yields and availability subject to change

    The $247 trillion global debt bomb…