GUEST COMMENTARY: Eye on Wall Street: Raging bulls keep raging; munis up
That’s a fair description of the U.S. stock market. But it’s not true overseas and certainly not in the bond market.
The S&P 500 was up 5.1 percent in July and 19.6 percent year-to-date. The EAFE index of overseas developed equity markets matched the U.S. last month jumping 5.3 percent on signs that Europe may be exiting recession and strength in Japan. EAFE is up 9.6 percent year to date. The Emerging Markets gained 1.1 percent in July but are off 8.6 percent so far this year as economic growth in many countries appears to be slowing.
Earnings for large companies in the U.S. have been soft with second quarter earnings up 3.9 percent year over year, but actually down if you exclude the banks. It looks like modest economic and employment growth, along with tepid inflation, is a goldilocks scenario for the markets; not too hot, not too cold — just right.
Bond yields seem to have reached equilibrium after the selloff in May/June. Ten-year Treasuries ended July yielding 2.58 percent. The Barclays Aggregate Bond Index gained 0.1 percent in total return, but is down 2.3 percent year to date. Municipal yields rose further sending ratios above 100 percent of Treasuries. Flows out of municipal funds continued on the possible fallout from Detroit.
Motor City runs out of gas
Detroit fell into Chapter 9 bankruptcy, making it the biggest municipal default ever. The long slide of the auto industry and financial mismanagement were the main culprits. Years of corrupt politicians buying votes partly via generous wages and benefit packages for the municipal unions resulted in unsustainable budget deficits and $18 billion in debt, half of which is unfunded pension and healthcare liabilities. The unemployment rate in the city is 16 percent and median income, at $27,000, is about half the national average.
What has got the municipal markets attention has been the move to classify about $1 billion in GO bonds as unsecured creditors along with everyone else. That is despite the pledge of the full faith and credit and unlimited taxing power backing the bonds. I guess just like the GM bankruptcy everyone has to shoulder “their fair share,” secured creditor or not; to heck with the rule of law.
What does this say about the creditworthiness of other GO bonds – which represent about 30 percent of the municipal market?
It is too soon to say. We can judge ability to pay based on criteria such as the economy, financials, debt levels, etc. but what of willingness to pay?
I am reminded of this exchange between J.P. Morgan and lawyer Samuel Untermyer when Morgan was hauled up before congress over 100 years ago.
Untermyer asked Morgan “Is not commercial credit based primarily upon money or property?”
Morgan: “No sir. The first thing is character.”
Untermyer: “Before money or property?”
Morgan: “Before money or property or anything else. Money cannot buy it ... because a man I do not trust could not get money from me on all the bonds in Christendom.”
Now I understand that as a banker you can judge a loan applicant’s character on past behavior and personal relationships. And you’ll always have an ear to the ground in the local community.
But how do you do that in the vast municipal market?
APCM emphasizes high quality GO bonds and essential service revenue bonds in the portfolios that we manage. The latter are less sensitive to the economic cycle and their revenue stream is more stable. They are often natural monopolies. We’re talking about local water and sewer bonds, electric utilities, toll roads, and airport revenue bonds.
Right now tax-free AAA rated municipals are yielding more than Treasuries. They are on sale and investors should have their buying shoes on. But stick to high quality.
Jeff Pantages, CFA, is the chief investment officer for Alaska Permanent Capital Management, a $2.4 billion investment management and advisory firm located Anchorage.