Why I Am Taking Profits on State and National Muni Bond ETFs

Includes: BAB, CMF, HYD, MUB, NYF
by: Gary Gordon

I represent asset management clients all around the world. With that said, I live and work in the least fiscally responsible state in America: California.

This is a state that has amassed a staggering $26 billion budget deficit. Worse yet, California has the 3rd-highest unemployment rate in the nation; a modest recovery in hiring may translate into modest gains in tax revenue, but that recovery will barely make a dent in the operating budget.

It follows that the Golden State is issuing new muni debt like there’s no tomorrow. Reception for the “junky” obligations have been decidedly tepid. (Perhaps ironically, fortune seekers once flocked to the Golden State to get rich from the yellow metal. Now, wealth makers would be wise to avoid taking up residence and to hold SPDR Gold (NYSEARCA:GLD) instead.)

For these reasons and a half dozen others (6/2009 “State Muni ETFs… Why Risk It?“), I had steadfastly recommended that national muni bond investing was the only reasonable alternative. And over the last 18 months, National Muni Bond ETFs were one of my better risk-reward income producers in taxable accounts.

No longer.

When the Fed announced its QE2 plan to buy treasury debt with an average duration of 6 years, longer maturity treasury bonds sold off viciously. I accurately forecasted both the Fed’s targeted duration as well as the treasury bond sell-off. I even expected the eerily similar reaction by longer maturity muni bonds.

However, I did not anticipate either the breadth or the extent of the selling across the muni landscape. Apparently, there were more facets to the story.

I’ve highlighted some of the additional factors below. And, in fact, these additional factors have persuaded me to take profits on all Muni Bond ETFs in my actively managed accounts.

1. Republican Congressional Victories. For a long time, I felt reasonably comfortable with the probability that if necessary, the U.S. government would bail out “too-big-to-fail” states. Yet there’s Republican disdain for aiding fiscally irresponsible, left-leaning California, Illinois and New York. Republicans are also keenly aware of bailout fatigue. Moreover, Republicans have less love for BABs – municipal bonds in the taxable market that receive a 35% federal government subsidy. It follows that you may not want to be cozy with iShares S&P Cali Muni (NYSEARCA:CMF) or PowerShares Build America Bond (NYSEARCA:BAB).

2. The “Will They Or Won’t They” Factor. Nothing kills a market-based security like uncertainty. And the uncertainty surrounding munis is mounting, not dissipating. Which municipalities will default? Which states? What does my bond mutual fund or Bond ETF hold? How would some debts be restructured if a state or local municipality is under siege? If fears persist, will it draw out for months like it did in Greece?

Profit-takers, myself included, are shooting first and then asking these questions. And while I believe the greatest likelihood will be a series of bailouts — either by acts of Congress or by Federal Reserve maneuvers — current risks are weighing heavily on current rewards. If you have profits on iShares S&P National Muni (NYSEARCA:MUB) or Market Vectors High Yield (NYSEARCA:HYD), consider cashing in.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.