No, Meredith Whitney, Detroit's Bankruptcy Is Not Going To Lead To A Wave Of Municipal Defaults
But we have heard this tale of terror one time too many. Unlike the first time Whitney tried to scare us about munis, the bond market is not having a panic attack today. Nor should it.
The following chart compares the yield of a municipal bond index (bond buyer index, general obligation, 20 years to maturity, mixed quality) to the yield of the 20-year treasury.
Click to enlarge.
If the long-term trend in this chart continues, then municipal bond yields will rise (and will continue to rise) once treasury yields stop falling. How's that for scary? Want scarier? The declining long-term linear trend has actually failed. The Great Recession caused it to go from bad to worse.
I'm therefore willing to offer an opinion.
Yes, Meredith Whitney, over the long-term Detroit's bankruptcy could very well lead to a wave of municipal defaults. For what it is worth, I'm not a big fan of investing in declining linear trends breaking to the downside. I have had no desire to invest in municipal bonds at any point in my life. I feel no great need to start now.
This is not investment advice.
Source Data:
St. Louis Fed: Custom Chart
Every now and then I come across an article by this chap.
ReplyDeletehttp://www.zvibodie.com
I see he has now cooled on TIPS but is still warmly attached to I-Bonds.
If the long-term trend in this chart continues, then municipal bond yields will rise (and will continue to rise) once treasury yields stop falling.
ReplyDeleteIs that right? I'm confused.
dearieme,
ReplyDeleteI watched the video. As you can probably guess, I'm mostly a believer in his investment style.
I was willing to swing for the fences when I had a job to fall back on and I was not nearly as cynical about the future prosperity of our country.
Since 2004, I'm at least as risk averse as he is. I'm absolutely done when it comes to swinging hard to hit the ball. I'm plenty content just walking to first base. Based on the accuracy of the pitches thrown over the last decade or so, I'd say the economy's pitcher is drunk!
mab,
ReplyDeleteIn the early 90s, this muni-bond index yielded about 1% less than a comparable 20-year treasury. The tax-free nature of the muni-bonds helped lower their yields.
Now this same muni-bond index yields about 1% more.
The long-term trend in the chart implies that these muni-bonds are therefore becoming increasingly more risky compared to treasuries. All things being equal, higher yields equals higher risk.
If it is true that they really are becoming more risky compared to treasuries over the long-term (the trend in the chart continues), then muni-bond yields must go up if treasury yields stop falling. We know that treasury yields must stop falling at some point. 0% is a hard floor.
I'm not claiming that the trend will continue long-term. I'm just saying what must happen if it does. That said, I see little compelling evidence that the trend won't continue. I'd certainly not bet on a long-term trend reversal.
mab,
ReplyDeleteI should also point out that municipal bond yields have fallen over the past few decades, just not as much as treasury yields have.
I strongly suspect that that there are two forces at play and they've been at play for at least 2 decades.
1. There's pressure for muni-bond yields to rise as they become more risky.
2. There's pressure for muni-bond yields to fall as treasury yields fall.
If I am right, then #1 will overtake #2 at some point.
None of us know if any past trend can be accurately projected into the future.
ReplyDeleteBut assuming the trend continues, munis are way below trend indicating that their yields should fall - a return to the trend (back to the red line).
In my mind, treasuries lead and all other financial products follow. Further, short term rates lead long term rates.
The above aside, I hear what you are saying and admit you could be right.
mab,
ReplyDeleteNone of us know if any past trend can be accurately projected into the future.
I absolutely agree.
But assuming the trend continues, munis are way below trend indicating that their yields should fall - a return to the trend (back to the red line).
My commentary is mostly aimed at the long-term declining trend. I would agree that muni yields could rise back to the trend in the short-term. I am generally a believer in return to the median theories.
That said, the operative word is "could" though. It is disturbing to me to see the trend fail and that the failure was not a reversal, but an acceleration in the same direction. That's what this trend did.
In my mind, treasuries lead and all other financial products follow. Further, short term rates lead long term rates.
Yeah, there's where I stand too. I agree that there is pressure on muni yields to the downside due to this. However, I also believe that there is increasing pressure to the upside as well. Detroit?
Just opinions of course. It is also my opinion that I don't trust municipal bonds any further than I can throw them.
1. As seen in the chart, the Great Recession weakened them.
2. I do not believe that the Fed has permanently put a stop to recessions.
3. The next recession may seriously weaken them further, whenever it comes.
The operative word is "may". I lean heavily that way, but I would not bet my life savings that I am right. Well, I kind of am I guess. I have and continue to avoid buying muni-bonds. I just don't want to risk my nest egg on it.
"I'm absolutely done when it comes to swinging hard to hit the ball." I once saw this put as "If you don't need the extra reward, don't take the extra risk".
ReplyDeletedearieme,
ReplyDeleteUnderfunded pension funds need the extra reward.
They seem to be swinging at anything within 3' of the plate, and hard! Let's hope that extra risk pays off for them. I have my doubts! Sigh.