I’m hoping, as are most readers, that the worst is behind us and we are now in a rebuilding phase. But even if that’s true, the “laissez le bon temps rouler!” (“let the good times roll!") attitude of many consumers, most real estate buyers, and all politicians means neither the federal government nor any state government put aside any money for a rainy day but, rather, spent everything that came in during the good times leaving nothing as a cushion for the bad times.
That doesn’t mean the markets must go down. Nor does it mean that some sectors won’t do very well. Even in the worst of times, there are always breakthroughs in technology and health care, to name but two examples, where an individual company will discover an advance so compelling that it grabs the imagination of investors. And even in the worst of times, people gotta eat, gotta motate, and gotta invest in something – anything – that preserves their future purchasing power. That’s why food and agriculture, energy and other essential commodities, and stores of value like gold and silver can march to the beat of their own drummer.
But there is one area that I believe must work its way through its biblical “7 lean years” and that is municipal bonds. Without State & Federal handouts (fat chance!) I see a disaster brewing here -- and an opportunity for those willing to bet against them. Regrettably, any decline will hit the most conservative of investors, those who have been led to believe by brokers and rating agencies that they will be just fine if they stick with “quality” municipal bonds.
Why do I say “fat chance” of getting a bailout from a state or the feds? Because almost no state has the assets to bail out its cities and counties. And, in an election year, even the dullest of national-level politicians won’t dare take money from Texans or Alaskans or Floridians to give it to profligate states.
Municipalities have always derived a good chunk of their revenue from state subsidies. That’s only fair, since the “state sales taxes” are collected equally from residents of every city and county but it is the “City of Wherever” that must provide fire, rescue, police and other essential services.
But this time around, at least 45 states that I could find good numbers for are showing declines in total tax revenues. The average decline in total state tax revenue was between 12% and 16%. So what are most of these brilliant leaders doing to replace tax revenue? Creating jobs? Slashing taxes to encourage new businesses? Cutting spending? Of course not. By and large they are raising taxes, getting more and more from fewer and fewer. And the fewer and fewer are voting with their feet.
The cost of a one-way U-Haul truck is a pretty good indicator of where people are going. If the destination is an unfavorable one, prices are low. But if it is so popular that there are more people wanting rental trucks than there are trucks available to rent, prices will rise. Simple supply and demand. If the unpopular destination gets unpopular enough, U-Haul might even have to pay people to dead-head their trucks back to where the Diaspora originates. We’re not quite to that point yet, but the cost of a one-way rental from Austin, Texas to San Francisco, California is $900. From San Francisco to Austin, the cost is $3,000.
Using California and Texas as examples, California, which has the nation's highest personal tax rate of 10.55% (state only -- New York state and City together are even higher), has drastically cut back on the basic services citizens have a right to expect in exchange for their tax levies but raised taxes across the board.
Texas, on the other hand, enjoyed a balanced budget in 2009, even as it cut taxes for 40,000 small businesses. (In 2008, Texas created more jobs than the other 49 states combined.) Think New York is home to the most Fortune 500 companies? Not any more. Capital goes where it is welcomed and well-treated. Think that means California is #1 in this department? Could have been, but they blew it. It’s Texas that is home to 58 Fortune 500 companies.
It’s also low-tax Texas that ranks #1 as the state people relocate to most. It’s now Texas that is home to America's highest-volume port, not Long Beach, New York or the Port of LA. Of course, Texas shares one additional quality with my home state of Nevada – besides being a haven for wealthy Californians who are deserting the state in droves, leaving behind those who need the most social services, welfare, etc., both Nevada and Texas only allow their state legislature to meet every other year. "No man’s life, liberty, or property are safe while the Legislature is in session.” (Erroneously attributed to lots of famous Americans; in fact it began with an obscure New York court decision in 1866.)
Of course, there are hundreds of “taxes” that are called something else and when states don’t want to be seen as “raising taxes” they simply increase their license and fee structure. Last year’s $25 hunting or fishing license might be $400 this year. But they didn’t raise taxes!
A parking ticket in San Francisco last year? $25. This year? $54 if paid within 30 days, with $25 added every month and turned over to an expensive-to-the-taxpayers outside collection agency if not paid in 2 months. Radar detectors are now illegal in California and the state as well as many municipalities are ticketing for even a couple miles over the speed limit. They don’t call any of these things taxes – but in fact they are a tax on those living or traveling in the state.
If you own bonds issued by municipalities in high-tax states, remember: capital goes where it is welcomed and well-treated.
In a jointly-issued report, the Rockefeller Institute for Government and the Brookings recently estimated that the funding shortfall in state and local governments will exceed $50 billion in another year. The states with the highest taxes also have some of the worst budget problems – no shock to anyone who understands the difference between individual entrepreneurialism and state-sponsored nanny-ism as practiced in high-tax, high-nanny-factor California, Vermont, Michigan, Oregon, Illinois, New York, and New Jersey. All of these states have already begun slashing revenue-sharing with their local governments.
That leaves a lot of local governing bodies that get their own revenue from property taxes, licenses and fees with declining revenue sources. What do I suggest?
First, if you insist upon holding munis, I suggest you ONLY own investment grade bonds (AAA, AA, A or, only for the gamblers out there, BBB.)
Second, research on your own via the ‘net or ask your broker what kind of cash reserves the issuer of your bonds maintains. Anything less than 18 months to two years...sell the bond while you can.
Third, buy “pre-refunded” or “escrowed to maturity” bonds. You’ll earn less with this money-in-the-bank-to-pay-at maturity kind of bond, but you should be every bit as concerned this year about the return OF your principal, not just the return ON your principal.
Finally, for those who aren’t long bonds and are willing to short municipals, here is a list of a few municipal bond ETFs (there are plenty more organized as closed-end muni bond funds, some of which are selling at premiums) that I think may be worth shorting. I have bolded and highlighted those that are, in my opinion, the two dumbest states whose problems are entirely of their own making and which, in my opinion, are hiding their heads in the sand (or somewhere): California and New York.
- CMF – iShares S&P California Municipal ETF
- CXA – SPDR Barclays Capital California Municipal ETF
- HYD – Market Vectors High Yield Municipal ETF
- INY - SPDR Barclays Capital New York Municipal ETF
- ITM – Market Vectors Intermediate Municipal ETF
- MLN - Market Vectors Long Municipal ETF
- MUB – iShares S&P National Municipal ETF
- MUNI - PIMCO Intermediate Municipal Bond Strategy ETF
- NYF - iShares S&P New York Municipal ETF
- PRB – Market Vectors Pre-Refunded Municipal ETF
- PVI – PowerShares VRDO Tax-Free Weekly ETF
- PWZ – PowerShares Insured California Municipal ETF
- PZA - PowerShares Insured National Municipal ETF
- PZT - PowerShares Insured New York Municipal ETF
- SHM – SPDR Barclays Capital Short Term Municipal ETF
- SMB – Market Vectors Short Municipal ETF
- SUB – iShares S&P Short Term National Municipal ETF
- TFI - SPDR Barclays Capital Municipal ETF
This list is not exhaustive. For instance, iShares just came out with 6 muni ETFs with a planned end-date, at which time the fund will be liquidated and the proceeds distributed to owners of record of the ETF – but all maturities are short ones and I believe the real carnage will be in the long bonds.
Do I predict 7 lean years for municipal bonds? Not literally. I don’t know if it will take a year or 7 years. I believe a shakeout is coming across all bond categories. (See my pan of long US Treasuries here.) It’s my job, for our firm’s clients, to shield them from that shakeout.
Many contributors at SA offer buy recommendations. But sometimes it’s even more important to suggest sectors to avoid or to sell outright…
Author's Disclosure: We are completely out of the bond funds we held during 2009. We are now long inverse Treasury ETFs TBT and TMV, and are looking to enter short positions for those clients for whom it is appropriate in the bolded, underlined ETFs above.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but did not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!
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