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The Fascinating World of Municipal Bonds

madhedgefundtrader's picture




 

I was fortunate to catch the muni bond wave this year with my recommendations to buy the funds in this sector, the (NCP) and the (NVX) (click here for “California Municipal Bonds Are a Steal” at http://www.madhedgefundtrader.com/march_26__2010.html ). I turned negative on bonds of every description in August, fearing that the popping of the government bond bubble could take down the rest of the fixed income universe down with it (click here for “The Great Bond Market Crash of 2010” at http://www.madhedgefundtrader.com/august-30-2010.html ).

However, there may be some circumstances unique to certain individuals where hanging on to you muni bonds may make some sense. Treasury bond investors are not being compensated for their risk at current yields, but muni bond investors are. Ten year tax free munis are now yielding 2.58%, delivering an effective taxable rate of 3.97% for those in the top end 35% tax bracket.

If the Bush tax cuts are not extended, that yield jacks up to 4.27% for top earners. In the 30 year arena, the effective taxable rate is 6.38%, and a very generous 6.87% without the Bush cuts. That’s a lot in this zero yield world we live in. And let’s face it, taxes are going up a lot, no matter who won the election, making these bonds even more valuable in the future.

The risk of an outright default on this paper has been vastly overblown by the media. California’s $70 billion in general obligation debt, which is used mostly for infrastructure spending, is at the very top of the seniority structure, followed by $150 billion in retirement benefits debt. These claims are untouchable.

All of the budget cuts going forward will take place with the junior claims in the obligation structure, mostly schools and social services. That is why we are seeing rioting at the University of California at Berkeley and demonstrations at welfare offices. And with the stock market up 78% in 20 months, capital gains will start kicking in, which in peak years account for 40% of total state tax revenues.

For those who would rather leave slugging it out in the markets every day to the younger crowd, who despair at figuring out the “new normal”, or who don’t want to deal with the harsh reality that “buy and hold” is dead, this may be a good option. Sure, you almost certainly will have to take some ugly marks down the road. But if you are willing to hold this paper to maturity, it might be worth it.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

 

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Fri, 11/05/2010 - 10:38 | 702530 Whatta
Whatta's picture

smells to me like any holder of government debt has a real risk of getting a partially fleecing in the future. no way the FED can print enough playdough to pay off all obligations everywhere. and, we the sheeple aren't getting paid an amount that we can afford much more in the way of taxation. add those together and it smells like restructuring and/or defaults coming at least for some.

Fri, 11/05/2010 - 10:27 | 702502 JimboJammer
JimboJammer's picture

Good  job  Zero Debt..   I  am  glad  you  could  find  that  info..

Greece  and  the  other pigs  are  very  upset...

it  will  spred  to  england   and  usa..

Fri, 11/05/2010 - 10:09 | 702452 technovelist
technovelist's picture

Municipal bonds are excellent if you want to lose your money. Defaults by the large insolvent issuers are inevitable.

That is, unless they are bailed out by the US government and/or the Fed, which is of course possible.

In that case, you will get the "dollars" you are promised, but they still won't be worth very much, if anything.

Anything denominated in "dollars" cannot be more valuable than the "dollars" themselves.

Fri, 11/05/2010 - 10:38 | 702532 Popo
Popo's picture

So the default is inevitable, unless there's a bailout in which case it's possible?

...which pretty much makes default 'not' inevitable.

Fri, 11/05/2010 - 09:22 | 702323 Zero Debt
Zero Debt's picture

ECB Rejects Request for Greek Swap Files, Citing `Acute' Risks

More horror is coming out of europe at this very hour. We discover that ECB has piles of undisclosed credit dirt on its books.

The European Central Bank refused to disclose internal documents showing how Greece used derivatives to hide its government debt because of the “acute” risk of roiling markets, President Jean-Claude Trichet said.

So much for the new transparency and clarity of policy that was supposed to bring stability and peace. And, as if it wasn't obvious enough that ECB does not think very highly of the market's ability to value information:

“The information contained in the two documents would undermine the public confidence as regards the effective conduct of economic policy,” Trichet wrote in an Oct. 21 letter in which he rejected the appeal."

http://www.bloomberg.com/news/2010-11-05/ecb-rejects-request-for-files-o...

Fri, 11/05/2010 - 09:18 | 702311 Stuck on Zero
Stuck on Zero's picture

QE 3 will most certainly be the Fed buing two trillion in munis.

Fri, 11/05/2010 - 08:41 | 702230 junkhand
junkhand's picture

high yield munis (or junk bonds as your broker calls them when you aren't around) are a great play!

Fri, 11/05/2010 - 08:37 | 702218 Grand Supercycle
Grand Supercycle's picture

Daily and weekly overbought charts are now at an extreme level. Similar extreme conditions were detected before the correction started in mid 2007.

http://stockmarket618.wordpress.com

Fri, 11/05/2010 - 08:32 | 702193 apberusdisvet
apberusdisvet's picture

But But But............Californicators of their own minds are entitled to American taxpayer dollars; there will never be a default;  Barbara "call me Senator, please" Boxer will ensure it; until, of course, the inevitable happens.

Fri, 11/05/2010 - 08:18 | 702169 JimboJammer
JimboJammer's picture

Sometime  the  bond  holders  will  get  a  haircut  (  30 % )

anywhere  in  the  world..  not  just  calif..

Fri, 11/05/2010 - 03:10 | 702042 pussfeller
pussfeller's picture

Cali is now 1/2 to spend, and 2/3 vote to get, with the People's and Union's Chosen one in power. How is that not going to cause the complete destruction of Cali's credit?

Fri, 11/05/2010 - 09:50 | 702402 praetorian
praetorian's picture

Madhedge didn't even bother to read the propositions to understand this fact, before spouting off on the ramifications of the CA election.

 

Makes you wonder about the rest of his analysis, doesn't it?

 

Cheers,

prat

Fri, 11/05/2010 - 02:16 | 702010 rotsevni
rotsevni's picture

"The risk of an outright default on this paper has been vastly overblown by the media. California’s $70 billion in general obligation debt, which is used mostly for infrastructure spending, is at the very top of the seniority structure, followed by $150 billion in retirement benefits debt. These claims are untouchable."

Ask the GM bond holders how that worked out for them.


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