Municipal Debt Funds: Are These Yields Unsustainable?

Includes: IQI, NAN, PCK
by: Karl Denninger

I'd pay attention to these.....

That's Morgan Stanley Quality Municipal Income Trust (NYSE:IQI), a levered municipal bond fund. It yields 6.5% at present - totally unsustainable in today's zero interest rate policy environment. At that discount (from recent price destruction) you're either getting the buy of the century or the portfolio is about to detonate in your face. Pick one.

This would be California municipal debt run by PIMCO. Yielding 7.8%! Again, you're either getting the buy of the century here, or you're about to get utterly destroyed.

Then there's New York. At today's price, this yields 5.8%. Again, either you're getting the buy of the century on this fund or you're fixing to get utterly trashed in the coming months.

Note that the last time we saw this sort of distortion the fund price declines were correct and they presaged a detonation in the stock market. Yes, they were early - substantially so in the case of some of these. But they were correct - the credit market usually is in leading the stock market.

So here's the deal folks. If you believe that everything will be ok, then you're being given an absolute gift with the ability to buy a broadly-diversified municipal portfolio that yields 6.5% tax free in the case of IQI, and even more in the case of the California-specific fund (which is quite attractive if you live in California, as it would be state tax free as well).

But if these early warnings are correct, this "reach for yield" is a warning of rank destruction that is soon to follow. I would be extremely careful here - the last time we saw this sort of rapid deterioration the bond market was right and while the stock market did continue to putter along higher for a while, you were being told to get short, not buy - and especially not buy these issues.

For an indication of how bad it can get, IQI was cut by more than half in principal value into the depth of the collapse. Those who bought it near the bottom have made a hell of a lot of money in capital gains - if they take the money.

I'm not touching these. In normal times I'd be all over these instruments as a way to earn a very nice income without paying any Federal Income Tax - legally. However, the risk of a 50% principal haircut doesn't interest me one bit.

You can bet there will be lots of people trying to entice you to buy into these "dips."

Before you do it make sure you look at a five year daily chart for exactly what you might be buying into.

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