With headlines blazing “Arma¬geddon,” the normally sleepy municipal bond market is finding itself center stage in the current “name that crisis” championship.
In seeing the sovereign debt crisis spread across Europe last summer, many of the talking heads in the media have begun to pick on struggling states and municipalities as the potential next proverbial shoe to drop. But how likely is it that they would default on their debt obligations.
In my recent conversations with a portfolio manager, an interesting tidbit came forward which I found interesting with regard to municipal securities:
“It is important to focus on higher-quality issuers that provide services that are essential to their communities. This “recession-proof” revenue stream from projects that are critical to the state’s progress, such as hospitals, education, transportation, and utilities, is where investors need to concentrate in this environment. This means carefully-selected essential service revenue bonds should currently be the foundation of a municipal portfolio and likely provide the most stability. Government obligations (“GO”) bonds still face significant challenges with budget constraints and public employee benefits producing high price volatility and the potential for downgrades. Finding issuers with little to no underfunded pension obligations and strong reserves will be challenging, but this is where stability will lie in the GO space.”
The take-away here is that not all Munis are created equal and the pros who are good at managing these types of portfolios should still be able to separate the wheat from the chaff.
Monday, January 31, 2011
Friday, January 14, 2011
The 5 Biggest Surprises from 2010
#1 No Rise in Interest Rates
With interest rates at record lows to start the year, most investors probably believed we were in for at least a minor increase. It looked like rates would tick up, but with sovereign debt worries in Europe peaking at mid-year in Greece, the Fed probably kept rates low to avoid a potential double-dip recession. Couple that with another round of Treasury purchases, and rates hit a low at 2.4 %. But overall, it was a decent year for bond investors, with modest gains across most high-quality bond categories, and even larger returns to riskier areas, such as corporate high yield and emerging-market debt.iii
#2 European debt crisis could bring us down
The spring of 2010 brought the potential for a sovereign debt crisis across the Euro zone. Issues kicked off in Greece as government bonds spiked above 13%, causing the currency to lose significant value, and thus raising fear and volatility throughout global financial markets. A $1 trillion rescue fund was created by the European Central Bank to address future similar problems, and the volatility was quelled temporarily. Ireland became the next problem a few months later, and even later in the year further discussion about Portugal and Spain began. Despite the fact the euro is the world’s second most-important currency and the Euro-zone’s economy accounts for 15% of global output, the region’s sovereign debt turmoil did not derail the global economic recovery. European sovereign debt uncertainty may well continue in the year ahead, but the good news in 2010 was the showing of the world economy’s ability to shrug off these types of events.
#3 U.S. stocks remained unloved by mutual-fund investors
With the S&P 500 up nearly 90% from the March 2009 lowiv, history suggests that investors would be flocking to jump into the next potential bull market. The statistics show that through October, mutual fund investors pulled a net $64 billion out of U.S. stock funds during 2010, and continued to feed bond funds instead. Are we also seeing the feeding of another bubble…this time in bonds? Perhaps it is the more conservative mindset of investors, or the aging population seeking income-oriented investments, but I expect interest in the bond market to continue into 2011. With stocks having made a serious comeback from crisis lows, I also expect equity funds to garner some more attention than in 2010.
#4 Ironies abound in “2-speed”, imbalanced world
It is widely acknowledged that developing economies, such as India and China, have grown much faster than developed nations and are expected to do so for some time into the future. In a world full of contrasts and imbalances, that was just the beginning. The Euro-zone dichotomy included a periphery where Spain’s unemployment rose above 20%, and Ireland and Greece slumped back into recession, while Germany’s economy
rode blockbuster export growth to a near-two-decade low in unemployment.vi Commodity markets flourished, with agricultural commodities and copper returning to mid-2008 record levels, while core inflation rates in the U.S. hit 50-year lows. Within the U.S. economy, the residential housing market languished as sales slumped and foreclosures bulged, but corporate capital spending was brisk. Unemployment remained stubbornly high near 10%, but consumer spending picked up steam throughout the year.vii Corporations borrowed at record low rates, but more than 150 banks failed in 2010, and getting a residential mortgage without a high credit score was a futile effort.viii
#5 Gloves come off in currency debate
The Fed’s latest round of Treasury buying called quantitative easing or QE2, had set off some worldwide currency tensions. Some countries finance ministers have argued this as an effort by the US to devalue the dollar. Right now, no major country wants their currency to strengthen in an effort to keep exports of their goods attractive. I expect currency to play an ongoing role, and China’s ongoing valuation of the yuan will be central
Boring…but, a solidly average year
After a calamitous 2008, and a huge rebound in 2009, I picked 2010 to be important for getting us back to a “normal” market. A modest double-digit return on financial markets is a nice average year, and it could not come at a better time after the violent volatility of the previous market cycle. 2010 reaffirmed that you can’t predict market behavior by looking at the daily headlines.
[i] Greece’s 10-year bond yield hit 13.17% on 5/7/10. Source: Financial Times,
Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[ii] On April 5, 2010, the 10-year Treasury yield hit 4.01%, then fell to 2.41% on
10/6/10. On Dec 2, 2010, the 10-year Treasury backed up to 3.01%. Source: Federal
Reserve Board, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[iii] All references to asset classes in the article and their respective U.S. dollar
returns (%) for 2010 are as follows (unless otherwise noted): Large Caps – S&P
500 Index (13.4%); Small Caps – Russell 2000 Index (24.9%); Developed Country
Stocks – MSCI EAFE Index (7.4%); Emerging Markets – MSCI Emerging Markets
Index (16.2%); High Yield – Bank of America Merrill Lynch U.S. High Yield Master
II Index (14.3%); Investment-Grade Bonds – Barclays Capital U.S. Aggregate Bond
Index (6.2%); Real Estate – NAREIT Equity-Only Index (22.7%); Commodities – S&P
GSCI Commodity Index (5.7%); Gold – London Gold Bullion, PM Fix US$/Troy Oz.
(28.6%). Source: FactSet, Wall Street Journal, FMRCo. (MARE) as of 12/13/10.
[iv] U.S. Stocks represented by the S&P 500 Index, which appreciated 90.3% from
3/9/09 to 12/13/10. Source: FactSet, FMRCo. (MARE) as of 12/13/10.
[v] Year-to-date net fl ows for U.S. equity and bond funds were -$64 billion and
$223 billion, respectively, through October 2010. Weekly net bond fund fl ows
turned negative the last two weeks of November 2010. Source: Investment Company
Institute, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[vi] Spain’s unemployment rate was 20.7% in Oct. 2010, while Germany’s was
7.5% in Nov. 2010. Source: Statistical Offi ce of the European Communities, Haver
Analytics, FMRCo. (MARE) as of 11/30/10.
[vii] The High-Grade Copper COMEX spot price ($/lb) reached an all-time high
of $4.20 on 12/13/10. The S&P 500 GSCI Agricultural Commodities Index stood
at 486.22 on 12/13/10, very near its high of 499.25 set on 3/12/08. The U.S. core
infl ation rate was 0.59% year-over-year, an all-time low. The S&P/Case-Shiller
Home Price Index of 20 metro areas is down 0.05% from Jan. 2010 to Sep. 2010.
The number of new consumers with new foreclosures was 457,000 in Q3 2010.
Gross private domestic investment grew 22.4% year-over-year in Q3 2010. The
unemployment rate in Nov. 2010 was 9.8%. Personal consumption expenditures
rose from $10.1 trillion in Q4 2009 to $10.4 trillion in Q3 2010. Source: Standard
and Poor’s, Bureau of Labor Statistics, Bureau of Economic Analysis, Haver Analytics,
FMRCo. (MARE) as of 12/13/10.
[viii] As of 12/10/10, the Federal Deposit Insurance Corporation stated that 151
institutions had failed or been assisted. Source: Federal Deposit Insurance Corporation,
Haver Analytics, FMRCo. (MARE) as of 12/10/10.
[ix] The S&P 500 fell 15.6% from 4/23/10 to 7/2/10, while gold appreciated by 6%.
Source: Standard and Poor’s, Wall Street Journal, Haver Analytics, FMRCo. (MARE)
as of 12/13/10.
[x] Corporate profi ts after taxes with inventory valuation and capital consumption
adjustments stood at an all-time high of $1.2 trillion in Q3 2010. Corporate liquid
assets of non-fi nancial corporations stood at $1.93 trillion as of Q3 2010, which
represented 7.4% of total assets. Source: Bureau of Economic Analysis, Federal
Reserve Board, FMRCo. (MARE) as of 9/30/10.
[xi] The S&P 500’s calendar year average from 1926 through Oct. 2010 is 11.8%.
Investment grade bond’s calendar year average from 1926 through Oct. 2010 is
5.7%. Investment-grade bonds represented by Barclay’s Capital Aggregate Bond
Index from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediateterm
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo.
(MARE) as of 10/31/10.
[xii] The range of returns for the major asset classes listed in footnote #3 above
(excl. gold) was 19.2 on a year-to-date basis through Dec.13, 2010, compared to a
historical average range of 51.5 dating back to 1988. Source: Ibbotson Associates,
FMRCo. (MARE) as of 12/13/10.
[xiii]The S&P 500’s standard deviation from 1926 through Nov. 2010 is 21.4%, while
year-to-date through Nov. 2010 it stood at 21.3%. Investment-grade bonds historical
standard deviation is 4.7%, while year-to-date through Nov. 2010 it was 2.6%.
Investment-grade bonds represented by Barclay’s Capital Aggregate Bond Index
from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediate-term
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo. (MARE) as
of 10/31/10.
With interest rates at record lows to start the year, most investors probably believed we were in for at least a minor increase. It looked like rates would tick up, but with sovereign debt worries in Europe peaking at mid-year in Greece, the Fed probably kept rates low to avoid a potential double-dip recession. Couple that with another round of Treasury purchases, and rates hit a low at 2.4 %. But overall, it was a decent year for bond investors, with modest gains across most high-quality bond categories, and even larger returns to riskier areas, such as corporate high yield and emerging-market debt.iii
#2 European debt crisis could bring us down
The spring of 2010 brought the potential for a sovereign debt crisis across the Euro zone. Issues kicked off in Greece as government bonds spiked above 13%, causing the currency to lose significant value, and thus raising fear and volatility throughout global financial markets. A $1 trillion rescue fund was created by the European Central Bank to address future similar problems, and the volatility was quelled temporarily. Ireland became the next problem a few months later, and even later in the year further discussion about Portugal and Spain began. Despite the fact the euro is the world’s second most-important currency and the Euro-zone’s economy accounts for 15% of global output, the region’s sovereign debt turmoil did not derail the global economic recovery. European sovereign debt uncertainty may well continue in the year ahead, but the good news in 2010 was the showing of the world economy’s ability to shrug off these types of events.
#3 U.S. stocks remained unloved by mutual-fund investors
With the S&P 500 up nearly 90% from the March 2009 lowiv, history suggests that investors would be flocking to jump into the next potential bull market. The statistics show that through October, mutual fund investors pulled a net $64 billion out of U.S. stock funds during 2010, and continued to feed bond funds instead. Are we also seeing the feeding of another bubble…this time in bonds? Perhaps it is the more conservative mindset of investors, or the aging population seeking income-oriented investments, but I expect interest in the bond market to continue into 2011. With stocks having made a serious comeback from crisis lows, I also expect equity funds to garner some more attention than in 2010.
#4 Ironies abound in “2-speed”, imbalanced world
It is widely acknowledged that developing economies, such as India and China, have grown much faster than developed nations and are expected to do so for some time into the future. In a world full of contrasts and imbalances, that was just the beginning. The Euro-zone dichotomy included a periphery where Spain’s unemployment rose above 20%, and Ireland and Greece slumped back into recession, while Germany’s economy
rode blockbuster export growth to a near-two-decade low in unemployment.vi Commodity markets flourished, with agricultural commodities and copper returning to mid-2008 record levels, while core inflation rates in the U.S. hit 50-year lows. Within the U.S. economy, the residential housing market languished as sales slumped and foreclosures bulged, but corporate capital spending was brisk. Unemployment remained stubbornly high near 10%, but consumer spending picked up steam throughout the year.vii Corporations borrowed at record low rates, but more than 150 banks failed in 2010, and getting a residential mortgage without a high credit score was a futile effort.viii
#5 Gloves come off in currency debate
The Fed’s latest round of Treasury buying called quantitative easing or QE2, had set off some worldwide currency tensions. Some countries finance ministers have argued this as an effort by the US to devalue the dollar. Right now, no major country wants their currency to strengthen in an effort to keep exports of their goods attractive. I expect currency to play an ongoing role, and China’s ongoing valuation of the yuan will be central
Boring…but, a solidly average year
After a calamitous 2008, and a huge rebound in 2009, I picked 2010 to be important for getting us back to a “normal” market. A modest double-digit return on financial markets is a nice average year, and it could not come at a better time after the violent volatility of the previous market cycle. 2010 reaffirmed that you can’t predict market behavior by looking at the daily headlines.
[i] Greece’s 10-year bond yield hit 13.17% on 5/7/10. Source: Financial Times,
Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[ii] On April 5, 2010, the 10-year Treasury yield hit 4.01%, then fell to 2.41% on
10/6/10. On Dec 2, 2010, the 10-year Treasury backed up to 3.01%. Source: Federal
Reserve Board, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[iii] All references to asset classes in the article and their respective U.S. dollar
returns (%) for 2010 are as follows (unless otherwise noted): Large Caps – S&P
500 Index (13.4%); Small Caps – Russell 2000 Index (24.9%); Developed Country
Stocks – MSCI EAFE Index (7.4%); Emerging Markets – MSCI Emerging Markets
Index (16.2%); High Yield – Bank of America Merrill Lynch U.S. High Yield Master
II Index (14.3%); Investment-Grade Bonds – Barclays Capital U.S. Aggregate Bond
Index (6.2%); Real Estate – NAREIT Equity-Only Index (22.7%); Commodities – S&P
GSCI Commodity Index (5.7%); Gold – London Gold Bullion, PM Fix US$/Troy Oz.
(28.6%). Source: FactSet, Wall Street Journal, FMRCo. (MARE) as of 12/13/10.
[iv] U.S. Stocks represented by the S&P 500 Index, which appreciated 90.3% from
3/9/09 to 12/13/10. Source: FactSet, FMRCo. (MARE) as of 12/13/10.
[v] Year-to-date net fl ows for U.S. equity and bond funds were -$64 billion and
$223 billion, respectively, through October 2010. Weekly net bond fund fl ows
turned negative the last two weeks of November 2010. Source: Investment Company
Institute, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[vi] Spain’s unemployment rate was 20.7% in Oct. 2010, while Germany’s was
7.5% in Nov. 2010. Source: Statistical Offi ce of the European Communities, Haver
Analytics, FMRCo. (MARE) as of 11/30/10.
[vii] The High-Grade Copper COMEX spot price ($/lb) reached an all-time high
of $4.20 on 12/13/10. The S&P 500 GSCI Agricultural Commodities Index stood
at 486.22 on 12/13/10, very near its high of 499.25 set on 3/12/08. The U.S. core
infl ation rate was 0.59% year-over-year, an all-time low. The S&P/Case-Shiller
Home Price Index of 20 metro areas is down 0.05% from Jan. 2010 to Sep. 2010.
The number of new consumers with new foreclosures was 457,000 in Q3 2010.
Gross private domestic investment grew 22.4% year-over-year in Q3 2010. The
unemployment rate in Nov. 2010 was 9.8%. Personal consumption expenditures
rose from $10.1 trillion in Q4 2009 to $10.4 trillion in Q3 2010. Source: Standard
and Poor’s, Bureau of Labor Statistics, Bureau of Economic Analysis, Haver Analytics,
FMRCo. (MARE) as of 12/13/10.
[viii] As of 12/10/10, the Federal Deposit Insurance Corporation stated that 151
institutions had failed or been assisted. Source: Federal Deposit Insurance Corporation,
Haver Analytics, FMRCo. (MARE) as of 12/10/10.
[ix] The S&P 500 fell 15.6% from 4/23/10 to 7/2/10, while gold appreciated by 6%.
Source: Standard and Poor’s, Wall Street Journal, Haver Analytics, FMRCo. (MARE)
as of 12/13/10.
[x] Corporate profi ts after taxes with inventory valuation and capital consumption
adjustments stood at an all-time high of $1.2 trillion in Q3 2010. Corporate liquid
assets of non-fi nancial corporations stood at $1.93 trillion as of Q3 2010, which
represented 7.4% of total assets. Source: Bureau of Economic Analysis, Federal
Reserve Board, FMRCo. (MARE) as of 9/30/10.
[xi] The S&P 500’s calendar year average from 1926 through Oct. 2010 is 11.8%.
Investment grade bond’s calendar year average from 1926 through Oct. 2010 is
5.7%. Investment-grade bonds represented by Barclay’s Capital Aggregate Bond
Index from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediateterm
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo.
(MARE) as of 10/31/10.
[xii] The range of returns for the major asset classes listed in footnote #3 above
(excl. gold) was 19.2 on a year-to-date basis through Dec.13, 2010, compared to a
historical average range of 51.5 dating back to 1988. Source: Ibbotson Associates,
FMRCo. (MARE) as of 12/13/10.
[xiii]The S&P 500’s standard deviation from 1926 through Nov. 2010 is 21.4%, while
year-to-date through Nov. 2010 it stood at 21.3%. Investment-grade bonds historical
standard deviation is 4.7%, while year-to-date through Nov. 2010 it was 2.6%.
Investment-grade bonds represented by Barclay’s Capital Aggregate Bond Index
from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediate-term
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo. (MARE) as
of 10/31/10.
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