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Default Was Not In The Stars
Released January 3, 2012 The Investment Strategy Group of Contango Capital Advisors provides regular updates on economic and financial conditions. In this issue, we assess the current state of the municipal bond market as well as ourexpectations for 2012.
As in each of the past three years, 2011 was a wild year for global stock markets. In contrast, the municipal bond market performed well, remaining almost eerily quiet with the exception of the well-telegraphed Jefferson County, Alabama, bankruptcy. You may remember that, during the fourth quarter of 2010, star analyst Meredith Whitney predicted “hundreds of billions” of dollars in municipal bond defaults in 2011. That prediction, of course, proved to be unfounded. In fact, missed bond payments in 2011 amounted to only $2.6 billion, according to Municipal Market Advisors, the leading municipal market datagathering service. Flight to Safety Returns were very strong as well. Yields fell and prices rose as investors sought the relative safety of municipal bonds amid stock market volatility, the threat of rising taxes, and perhaps a thought that existing bond holdings would be grandfathered should Congress tinker with the tax-exempt status of new-issue municipals. The latter eventuality is still a long-shot in our opinion. For the year, the Barclays Capital Municipal Bond index will likely post gains of more than 10%, an outstanding performance for a bond index. Granted, this is a long-duration index of middling credit quality, and most conservative individual investors are likely to focus on shorter-term high-credit-quality bonds. But even the 3-year Barclays index will have returned about 3.5% in 2011, easily beating global stock market returns. One of the reasons that munis performed so well was that supply was extremely light. Through November, new issues totaled only $267 billion versus $390 billion in 2010. And new issues targeting refunding made up a fairly significant portion of that total in 2011 as state and local governments again eschewed new projects and cut expenses, reducing aggregate muni debt outstanding by $60 billion to $70 billion. Additionally, investors continued to be attracted to taxable municipal bonds created by the 2009/2010 Build America Bond subsidy. The subsidy essentially created a new asset class that enabled taxable bond investors to further diversify their portfolios, and which pulled forward supply from the tax-exempt bond market to 2010 from 2011. Market Trends In 2012, we expect much more muted returns for municipal bond investors. Yields are unlikely to continue to fall, for example; they are already extraordinarily low – partly due to Federal Reserve tinkering in the US Treasury market. Also, it will not be easy for state and local governments to continue to cut costs, as most of the “low hanging fruit” in terms of expense management has likely been harvested. Indeed, governments still face challenges as the ongoing sluggish economy and uninspiring residential real estate market continue to weigh on revenue growth. Still, overall we do not expect defaults to spike materially in 2012 as conservative fiscal management continues to support credit quality, although they will probably rise. However, credit quality is not static. Thus, although US Treasury bonds continue to be the primary beneficiary of any widespread flight to safety, continuing deterioration in the nation’s fiscal situation could eventually separate Treasuries from their safe-haven status. Similarly, on the municipal level, real estate is assessed in arrears – sometimes years in arrears – which means that municipal finances can be expected to deteriorate through 2014. States that have failed to resolve their fiscal problems will confront the possibility of ratings downgrades and the threat of bankruptcies. In other words, Ms. Whitney was on to something, although her predictions were both overly dramatic and premature. Given the risks we see, we currently favor high credit quality issues such as better general obligation bonds as well as revenue bonds with relatively secure sources of repayment. We also currently favor short-duration bonds to protect against a potential rise in interest rates, which could come from either stronger economic growth or possibly a rise in Treasury rates related to fiscal issues that Washington fails to address. If you have a need for a highly customized individual municipal bond portfolio, please call your advisor who can work with our in-house municipal bond portfolio managers to put together a sample portfolio for you. The opinions expressed above are solely those of Contango Capital Advisors and do not necessarily reflect the views of Zions Bancorporation, its affiliates or its management.
IMPORTANT NOTE: Wealth management services are offered through Contango Capital Advisors, Inc. (Contango), which operates as CB&T Wealth Management in California. Contango is a registered investment adviser, a nonbank affiliate of California Bank & Trust and a nonbank subsidiary of Zions Bancorporation. Some representatives of CB&T Wealth Management are also registered representatives of Zions Direct, which is a member of FINRA/SIPC and a nonbank subsidiary of Zions Bank. Employees of Contango are shared employees of Western National Trust Company (WNTC), a subsidiary of Zions Bank and an affiliate of Contango. Investment products and services are not insured by the FDIC or any federal or state governmental agency, are not deposits or other obligations of, or guaranteed by, Zions Bank, Zions Bancorporation or its affiliates, and may be subject to investment risks, including the possible loss of principal value or amount invested. CCA1211-0210R |
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