Q4 2018 Credit Commentary and a Look Ahead to 2019

Has The Municipal Credit Cycle Plateaued?

Cumberland Advisors - Q4 2018 Credit Commentary and a Look Ahead to 2019

Many positive indicators suggest that the municipal credit cycle has yet to plateau. Upgrades continue to outpace downgrades; the US economy is still growing; federal tax reform boosted revenues in fiscal 2018; and rainy day funds or reserve levels in many localities are strong. However, pressures continue to confront municipalities. Pension burdens and retiree healthcare costs continue to rise, while infrastructure underinvestment and affordability of living in cities, along with rapidly changing technology, are among the other challenges. These and other factors are discussed in our Nov. 19th commentary, “Is the Municipal Market Sleepy?! Pension Doomsday?” (see http://www.cumber.com/is-the-municipal-bond-market-sleepy-pension-doomsday/). More recently, the limit on deductibility of state and local taxes, along with higher mortgage rates, seems to have driven down or slowed home price appreciation in some areas, and that trend could reduce property tax growth in the future.  John Mousseau mentions this in his recent commentary http://www.cumber.com/4q2018-review-munis-turn-it-around/.Stable may be the catchword for municipal credit over the near- to mid-term, which could indicate a plateau.

Moody’s recently released outlooks for state (Dec. 5) and local government credit (Dec. 6) over the next 12–18 months and considers them stable. Moody’s projects that states will see tax revenue increases of 3.5% to 4.5% in 2019, reflecting continued but slowing growth. Moody’s notes that this projection, if realized, would represent the tenth consecutive annual tax revenue increase. The outlook factors in continued spending pressure to fund pensions and retiree healthcare costs as well as anticipated pressure to increase education and Medicaid spending. The outlook anticipates, as a result of improved investment returns, a reduction in increases in the funded status of pension plans, a projection that may not materialize unless the market recovers. (See David Kotok’s “Stock Market and Tariff Truce,” http://www.cumber.com/cumberland-advisors-stock-market-and-tariff-truce/.)

With regard to federal funding, Moody’s outlook does not foresee large changes in spending for education and Medicaid. However, Medicaid, at 29.7% of state spending according to the National Association of State Budget Officers’ 2018 State Expenditure Report, is the largest and fastest-growing segment of state spending, at 7.3%. The stable outlook takes into consideration the buildup of adequate reserves by most states, which could provide a cushion and flexibility to manage through an economic downturn or changes in federal spending. The December 14th ruling by the US District Court in Fort Worth, Texas, held that the Affordable Care Act (ACA) is unconstitutional because of the individual mandate. However, the decision is expected to be appealed, and the case is ultimately expected to head to the US Supreme Court, while the law would remain in effect during the process. Thus, Moody’s anticipates that the decision will not have immediate credit implications for states, hospitals, or health insurers. Full repeal of the ACA would mean reduced federal spending on Medicaid and subsidies to individuals. Those states that expanded Medicaid would be most affected. Alternatively, there could be a partial repeal of the ACA or no repeal at all.

Moody’s stable outlook for local governments projects modest growth of 2–3% in property tax revenue and a 3% increase in total revenue, including sales and use taxes and state funding in 2019. Property tax revenues grew 3.7% in 2017 because many people paid their 2018 taxes early. Spending pressure is expected, mostly from increases in the personnel costs necessary for the management of pension and healthcare issues, as well as a need to have competitive salaries and benefits. Moody’s notes that most cities, counties, and school districts hold healthy reserves to manage through a downturn.

Of course, there are some states, such as Illinois, New Jersey, and Connecticut, and some cities that have outsized burdens and management and budgeting issues. Their lower ratings reflect those challenges.

State Ratings

Following two quarters of high activity (see our Q3 commentary: http://www.cumber.com/q3-2018-municipal-credit-commentary/), the only state rating actions this quarter were the downgrade of the State of Vermont by Moody’s from Aaa to Aa1 and the revision of two state outlooks by Moody’s. The State of Vermont’s downgrade reflects low growth prospects from an aging population, coupled with relatively high debt as compared with GDP and with shortfalls in funding for post-employment benefits. However, the still-high rating reflects a solid financial position and strong management. S&P has rated Vermont AA+ since 2000. Moody’s revised the State of North Dakota’s outlook to stable from negative as a result of progress towards structural balance coupled with rapid restoration of reserves as the economy and revenues continue to recover from the 2016 energy recession. Recent declines in oil prices will likely result in some economic and revenue volatility; however, the state’s energy economy and financial reserves are well-positioned to weather some short-term disruptions at this time. Also, Moody’s revised the outlook for Mississippi to stable from negative to reflect stabilization of revenue and economic trends and a resumption of deposits to the rainy day fund. The outlook also incorporates the expected continuance of conservative fiscal management, which will help manage elevated debt levels and potential future revenue weakness.

Midterm Elections Included Numerous Ballot Initiatives

In “Midterm Elections: The Quick Muni Note” (Nov. 7th – see http://www.cumber.com/midterm-elections-the-quick-muni-note/),John Mousseau discusses the bond-related advantages of a divided Congress. Here we recap ballot initiatives.

Medicaid expansion: Three states – Idaho, Nebraska, and Utah – voted to expand Medicaid, while Montana voters, by not approving a rise in tobacco taxes, struck down a measure to continue funding Medicaid expansion beyond the June 30th sunset date. Depending on the legislature’s actions, Montana could be the first state to end Medicaid expansion after having accepted it. Moody’s notes that 36 states, encompassing two-thirds of the US population, have approved Medicaid expansion. This broad implementation may make it more difficult to repeal or make changes to the ACA.

Infrastructure spending: Many state and local bond measures were passed, supporting housing, hospitals, education, transportation, and other infrastructure. In California numerous proposals for statewide bond issues funding housing and children’s hospitals were approved, including  a vote not to repeal an increase in fuel taxes that was due to expire and helps fund transportation spending.  However voters in the Golden State turned down a $9 billion water infrastructure initiative.  Further detracting from the spending trend, voters in Colorado, Missouri, and Utah voted down increases in taxes for roads and schools.

Restrictions in state flexibility: Six of ten ballot initiatives were passed that reduce legislative or executive flexibility to raise or manage revenue, an outcome that is generally credit-negative. For example, a two-thirds majority in the Florida Legislature will now be required to raise statewide taxes and fees, while Arizona now prohibits taxes on services, and North Carolina has voted to place limits on state income taxes.

There were numerous local bond and fee initiatives that passed as well. The results of the initiative process can affect credit quality and issuer flexibility, so it is important to watch how implementation evolves.

Trend to Fewer Ratings

The number of issuers seeking multiple ratings has declined since the financial crisis. Until the crisis, issuers often had debt ratings from two or more rating agencies. According to data collected by Municipal Market Advisors (MMA), issuers that were triple-rated (by Moody’s, S&P and Fitch – data on Kroll is not able to be queried yet) declined steadily from 55% in 2007 to 34% through 2017. Viewed another way, by the end of Q3 2018 there were 1.91 ratings assigned per dollar par issued, down from 2.29 ratings assigned per dollar par issued in 2007. The par value of bonds that are rated by just one rating agency has grown to 25% from 21% in 2007. The trend is likely a function of municipalities’ looking to reduce costs. Additionally, in the recent low-interest-rate environment with narrow credit spreads, fewer ratings on bonds have been sufficient to gain market acceptance, especially as investors chase yield. If credit spreads were to widen, a differentiation in yield might become visible among bonds with just one rating compared to those with two or more ratings, and this development could reverse the trend.

The trend to fewer ratings is a negative for investors. There could be “rating shopping” going on. The criteria, or areas of emphasis, applied by the rating agencies are different, and an issuer can choose the rating agency that it thinks will give its debt a higher rating. Having only one rating means there are fewer “eyes on” the credit and less frequent reviews. A bond with one rating is also subject to changes in the rating agency’s criteria, which could cause an abrupt change in the rating, up or down. With two or more ratings, there is more stability. This falloff in the number of ratings makes the case for active bond management and investment in higher-quality bonds, which is the strategy that Cumberland Advisors employs.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
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The November Bond Market Bounce

Here’s our first take after the midterm elections. The last three weeks of November have seen a bounce in the bond market, with intermediate and longer bond yields falling after spending most of 2018 rising.

Market Commentary - Cumberland Advisors - The November Bond Market Bounc

 

If we look at the US Treasury market (chart 1), we can see the rise in Treasury yields – across the board – from the end of 2017 to early November. A lot of this rise, in our opinion, was to give yields some competition with equity markets, which were certainly frothy early this year, in January, and then in late summer into September. In addition, better growth numbers for the economy, associated with last years’ tax cut, also helped push yields higher. However, core CPI is at 2.1% – approximately where it was at the time of the election in 2016 – though in early November the 10-year US Treasury yield was about 100 basis points higher, at 3.25%, than it was two years earlier. Thus, REAL yields had risen approximately 1% during this time period.

The November Bond Market Bounce Chart 01
Chart 01

 

Since early November we have seen 10-year US Treasury yields fall from 3.25% to 3% and 30-year US Treasury yields fall from 3.45% to 3.30%. Shorter yields have also declined. What’s going on? We think a number of factors are changing investors’ expectations about rates.
—(1) A slightly softer tone by the Federal Reserve is shifting expectations. While we expect to see the Fed raise the fed funds target in December to 2.25–2.5% percent, the markets certainly seem less married to the idea that we will see three or four rate increases next year.
—(2) Volatility in the equity markets has, we believe, led to some switching into bonds at the margin. Certainly, interest rates that are 80 basis points higher than at the start of the year and even HIGHER on a REAL basis have started to attract interest.
—(3) Previously hot real estate markets in the northeast, California, and other “hot” areas have now cooled. Homes that a year ago were often on the market for 4–5 weeks at most are now on for 4–5 months, and that time is lengthening. Bidding wars are now a thing of the past; and while the housing market may not be fully a buyers’ market, it has clearly transitioned from a sellers’ market. We think the provisions of last year’s tax bill, which dictated that state income taxes and local property taxes will no longer be deductible on federal taxes, are starting to have an effect now that we are less than six months from tax day. Clearly, areas that have high relative property taxes are grappling with what is now a higher after-tax cost of owning a home. Higher mortgage rates this year have also contributed to this cooling,
—(4) The market is reckoning with the fact that the increasing US government deficit will start to have ramifications that were not present over the past half dozen years.


In the charts above we see the growth in outstanding US government debt and Congressional Budget Office projections for future growth. We can see the growth of outstanding federal debt from $10.7 trillion in 2008 to an estimated $21.4 trillion at the end of this year. However, the net interest expense on that government debt barely budged between 2008 (at $252 billion) and 2017 (at $262 billion). But note the large jump this year and going forward. Interest expense on the government debt barely rose in the last decade because of ultra-low interest rates, particularly on shorter-term debt. The jump in interest expense going forward is a function of the higher interest rates in force today.

The November Bond Market Bounce Chart 04

For example, the above graph shows 5-year US Treasury yields going back more than a decade. Bonds that were issued in 2007 at 5% could be replaced when they matured in 2012 at a little more than 0.5%. We are now going the other way. Five-year notes that were issued in the middle of 2013 at around 1% were being replaced this year at almost 3%. This extra interest expense could act as a wet blanket on an economy that is still growing because of lower unemployment and tax cuts.

We think all of this activity has caused investors to ratchet down expectations. We have extended durations within our barbell strategy during the past two months and believe there are forces that should keep intermediate and longer-term interest rates in a trading range, with a bias to going lower. We believe that, with long Treasuries at 3.30%, longer tax-free municipal bond yields in the 4% range still represent excellent value – particularly in high-tax states that will be grappling with the SALT provisions of the tax bill.

We wish all our readers a great holiday season.

John R. Mousseau, CFA
President and Chief Executive Officer, Director of Fixed Income
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Is the Municipal Bond Market Sleepy?! Pension Doomsday?

Today’s municipal bond market is anything but “sleepy,” as Spencer Jakab characterized it in his Wall Street Journal article “Prophet of Muni Market Doom Wasn’t Wrong, Just Early” (10/26/2018). The Prophet of Doom he referred to was Meredith Whitney, who shortly before the financial crisis successfully predicted the damage to Citibank by bad mortgages. In 2010, on 60 Minutes, she contended that municipal market participants were not addressing or recognizing pension risk that would contribute to “50 to 100 sizable defaults” on municipal bonds over the next year. This comment caused a rout in the municipal bond market, but we now know that a large number of defaults did not materialize.

Market Commentary - Cumberland Advisors - Is the Municipal Bond Market Sleepy - Pension Doomsday
The market is heterogeneous. There are over 80,000 municipalities in the United States, and each of those entities can issue various types of debt, from general-obligation bonds backed by the taxing power of the municipality to revenue bonds that are secured by user fees such as water and sewer rates. Municipal bonds fund everything from fire trucks to schools to major road projects. Bond maturities can exceed 30 years. Thus, there are many investments to choose from. Municipal bonds offer tax-exempt income and can be used for impact investing,  because municipal bonds finance projects that have environmental, social, and governance (ESG) implications.

Many participants in the marketplace are aware of pension-funding shortfalls as well as the growing burden of providing healthcare to retirees and paying for long-term debt. They understand that if the problems aren’t dealt with, the financial implications down the road could be severe. Jakab’s article does not mention the states and municipalities that are taking action to improve pension funding status and what those actions are. That perspective could have helped WSJ readers and others, whether they are taxpayers, pensioners, or bond investors, to understand their towns and states better and take some action instead of being afraid.

Pension obligations are long-term and large. Just as an ocean liner takes a long time to turn, so, too, municipalities must anticipate in advance how to proceed. The pension issue does need to be addressed; however, it may not be an immediate threat in many jurisdictions. Actions that can improve pension funding include lowering the assumed rate of return on investments and fully funding or overfunding the actuarially required annual contribution (ARC) to the pension, (funding at this level keeps the funded level growing to meet future obligations). The municipality can alter certain pension benefits, for example by reducing cost-of-living adjustments or changing the level of benefits for future employees – all difficult decisions. Because liabilities can mushroom, it is important for municipalities with underfunded plans to make changes sooner rather than later. An increasing pension burden, just like your personal credit card debt, can balloon if you do not make more than the minimum monthly payment.  These payments can compete for spending on other items.

States that have been able to implement pension reforms include Ohio, Colorado, Minnesota, and Kentucky. Although the Kentucky changes are being challenged, there is now more recognition in the state that something needs to be done.

Many observers look at the unfunded status of a plan. For example, Pew Charitable Trust annually calculates those figures.  The average funded level of a state pension fund based on 2016 data is 66% with the lowest funded at 31% for New Jersey and Connecticut and the highest funded plan was Wisconsin at 99% funded.  Moody’s calculates an Adjusted Net Pension Liability (ANPL) by making changes in assumed rates of return, among other variables, to all state pension funds.  This makes state funded levels more comparable and realistic. Moody’s uses discount rates between at 3.0%–4.0% while most pensions still assume 6.5% to 7.5%. A lower discount rate increases the unfunded status of a plan so is more conservative.  Moody’s compares the ANPL with state revenue to rank the states based on the metric.  The highest ratios are for Illinois (600%), Connecticut, Kentucky and New Jersey (290%) while North Carolina, North Dakota, Wyoming and Utah have ANPL well lower as a percent of revenue at 45% or under.

Other post-employment benefits (OPEB), mostly healthcare, were historically funded on a pay-as-you-go basis. OPEB liabilities are now required to be recognized in accordance with accounting standards recently implemented for periods beginning after June or December of 2017, specifically Governmental Accounting Standards Board (GASB) Statements 74 and 75. This is a positive development, allowing a municipality and its citizens a more transparent view of fiscal health. It is even more important as retirees live longer and the cost of healthcare rises. Many healthcare benefits are not contractually fixed, as pension benefits are; however, reducing benefits may be politically unpopular, in effect making healthcare benefits almost as difficult to change as pensions are.

Technological improvements have helped improve efficiency at municipalities, but the improvements have also led to there being fewer current employees to support a growing retiree population, which further exacerbates the pension issue. Further developments in technology may give municipal managers pause as they determine which direction to invest in for the future.

There are other risks to the long-term economic viability of municipalities – exploding pensions are just one of them. There is the widely publicized issue of deferred infrastructure spending, which reduces livability and could be a negative for economic development and a safety risk to a community. Deferred spending also makes projects more expensive. In addition, there is the prospect of having to prepare for sea level rise, coastal erosion, and more extreme weather and fire events.

The increasing wealth gap and affordability issues affect social service spending and tax-rate and service-fee-rate increase management. Municipalities have many competing spending needs.

I’m not trying to paint a dire picture, but I am trying to impress upon readers and casual observers of the municipal market that market participants are in fact aware of long-term challenges. Ratings and credit analysis are based on many factors, including the strength of the service area economy, financial operations, long-term plans, and management performance. Ratings are not based on one item unless that one factor is overwhelming.

The fear of widespread municipal defaults in 2010 and the ensuing rout in municipal bond prices created a buying opportunity for investors that knew the market. For many investors, the timing of when to exit a bond is the issue. Do investors exit as soon as they see the light of the pension crisis train barreling down the track, or just before the train wreck? Conservative investors generally do not invest in the state obligations of Illinois, New Jersey, or Connecticut because of those states’ burgeoning pension and OPEB obligations (additionally these states suffer from slow or negative growth in population and dysfunctional governance). Cumberland, as a conservative investor, has avoided the bonds that would have suffered from the multiple downgrades of those states.

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
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Midterm Elections – The Quick Muni Note

Here’s our first take after the midterm elections.

Market Commentary - Cumberland Advisors - Midterm Elections – The Quick Muni Note

The polls actually got it right, with the Democrats taking the House of Representatives and the Republicans enjoying a slight pickup in the Senate.

Divided government, with different parties in control of the House and Senate, has sometimes led to gridlock.  It also tends to keep spurious legislation from being passed; and so overall, markets are OK with this outcome.

 

Regarding munis, we feel that this election certainly eliminates the concern that a Republican House would have introduced legislation to cut income taxes further.  With the Dems in control of the House, that notion is off the table; and fears that tax-exempt munis would suffer price erosion from lower marginal tax rates should dissipate.

From a spending standpoint, the divided Congress will most likely keep the President’s spending in check, and this may slow the current rise in the deficit (a good thing from our perspective).

We’re still checking final results, but we know that California voters rejected almost $9 billion in bonds for water projects, and Colorado rejected over $3 billion in a transportation bond.  There’s more to come on this issue of bond rejections, but our thought is that the specter of the SALT provisions of last year’s tax bill is forcing voters’ hands. If state income taxes and local property taxes are no longer deductible, anything that raises the level of spending and potentially higher taxes is likely to get a cold shoulder, as people’s EFFECTIVE taxes will rise in any case with SALT provisions.

We do believe that with the current low unemployment level, a national infrastructure program with federal subsidies is not needed and is now more unlikely with divided government.  We have seen large infrastructure bond deals done in the past year in the municipal market, and the issuers have had no problem selling the bonds.

Coming out of the elections, we feel especially constructive about longer-term tax-free bonds. With longer tax-free munis yielding over 4%, and with a taxable equivalent yield of 6.35% and muni/Treasury yield ratios of almost 120%, we feel longer tax-free paper is a real bargain and continue to manage portfolios in a barbell fashion, with longer-maturity bonds being a focal point.

The large December and January reinvestment periods are almost upon us. Supply is running 15% behind last year, and that will be another positive force for the market, along with the core inflation rate, which has been dropping for two months.

More to come.

John R. Mousseau, CFA
President and Chief Executive Officer, Director of Fixed Income
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Taxable Total Return First-Quarter Review

The first quarter of 2018 provided some long overdue volatility to equity markets while Treasury yields rose across the board. The long end of the yield curve underperformed during the month of January. Roughly 75% of the 35-basis-point move upward in the 30yr Treasury yield took place in the first month of the quarter, while the short end lagged the upward movement in yield. After experiencing steepening in January, the Treasury market reverted to a flattening trend as T-Bills and short-term Treasuries experienced the majority of their movement upward during the months of February and March, providing outperformance for the long end of the yield curve in those months.

This outperformance on the long end of the yield curve over the last two months demonstrates why we favor a “barbell” approach and maintain an allocation to longer-dated securities. While the weighting is small at this time, we are currently targeting new-issue longer taxable and tax-free municipals that have either an attractive spread over Treasuries (taxable) or an attractive muni/Treasury ratio in the 125–140% range (tax-free munis). New issues tend to offer a concession to the secondary market to ensure deals get done and provide a cushion against the increase in rates we have been experiencing. The chart below shows why we think the inclusion of tax-free municipals is beneficial to taxable portfolios in light of our expectation that the muni/Treasury ratio will correct itself as we move forward with the Fed hiking cycle.

Source: Bloomberg
On the short end of the barbell we continue to maintain the defensive assets we started purchasing at the beginning of the Fed’s hiking cycle. They include Treasury floating-rate notes, agency multi-steps, and T-bills that, as they mature, we will look to replace them, or reinvest the proceeds in better-yielding opportunities, depending on market conditions. We have also started to include a heavier weighting in investment-grade corporate bonds on the short end of the barbell as spreads have started to widen in that space. The Bloomberg Barclays US Corporate Index OAS hit its tightest level since 2007 on 2/1/2018 at +85 before widening out to +105 currently. In contrast, taxable municipals have not experienced this level of widening, creating an opportunity to allocate more cash to short-term corporate bonds. The chart below shows the change in the Bloomberg Barclays US Corporate Index OAS so far in 2018.
Source: Bloomberg

The Fed held its FOMC meeting on March 21st and delivered a widely anticipated quarter-point rate hike, lifting the fed funds target rate to 1.50–1.75%. The statement accompanying the meeting stated that job gains have been “strong” while economic activity has experienced “moderate” growth. The statement also discussed inflation remaining low, but the expectation is that it will move up and should stabilize around 2% over the medium term. The median forecast from the Fed’s “dot plot” currently predicts two more rate hikes this year, which is unchanged from the December outlook and in line with our projections.

As we move into the second quarter of 2018, Cumberland’s projection that the Fed will raise rates two or three times in 2018 remains unchanged. The FOMC will continue to take a judicious approach with regard to raising short-term interest rates and will focus on economic data and overall market conditions to determine whether to continue increasing rates. Our goal is to remain defensive in our approach to investing as we navigate a rising-interest-rate environment. We will continue making our investment decisions conservatively while extending durations and picking up additional yield as opportunities in the market develop.

Daniel Himelberger
Portfolio Manager & Fixed Income Analyst
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Chicken Little

We do not want to diminish the important debate about fiscal policy and budget austerity. It is global and it is critical. This commentary is about distinguishing between facts and unsupported, shrill, distracting assertions.

First, the US federal fiscal mess.

The FT.com link to the full story (subscription required) is http://www.ft.com/cms/s/0/31dbce8a-1f52-11e0-8c1c-00144feab49a.html#ixzz1BCXKIV3S. The numbers are real. The political hyperbole is not.

If the US does not get its finances in order “we will have a European situation on our hands, and possibly worse,” claimed Paul Ryan, the new Republican chairman of the House of Representatives budget committee. The consequences of not tackling the country’s mounting debt burden would be dire, he told an audience of leading budget experts and economists at a gathering in Washington last week. “We will have the riots in the streets, we will have the defaults, we will have all of those ugliness problems,” he said, referring to “French kids lobbing Molotov cocktails at cars, burning down schools because the retirement age will be moved from 60 to 62.” Source: FT.com

Really? Molotov cocktails in the US? Maybe that is enough of a threat to cause Congressman Ryan to push for repeal of billions in ethanol subsidies. They trigger high food prices and cause food riots in parts of the world. Ryan seems shrill to me. But it is political rhetoric and it is offered at the start of the budget negotiation and in the face of a debt-limit debate in the Congress. Anything less shrill would be a pleasant political surprise.

Now to Muniland.

Meredith Whitney continues to forecast large ”defaults” in the Muni sector. She is now saying that none of the 50 states will default but that 50 to 100 cities and $100s of billions of Munis will default. Chicken Little? Or Cassandra? Time will tell.

In Muniland, mutual fund redemptions are driving fund managers to liquidate tax-free Muni bond positions into a market with falling prices. Pricing references for bonds are used to reprice the estimated market value of all bonds. Very few Munis trade every day. The Muni sector is not like the stock market; pricing is not transparent. So unsophisticated investors watch their prices seem to fall and they hear the media hype and they panic. That triggers more mutual fund redemptions and the cycle repeats itself.

Right now, there are Munis backed by federally guaranteed payment streams that are trading at yields above their US Treasury counterparts. The Munis are tax-free. The treasuries referenced are taxable. Clearly, this is not about credit risk or default risk. We are talking about bonds that have the US government as the source of credit on both sides of the comparisons. Clearly, something else is going on.

Market anomalies happen and can be explained. This one is no different. On the sell side, you find a forced seller in the mutual fund. The manager of the fund has no choice because he must raise the cash to pay the redemption on the day it occurs. On the buy side, the retail investor is terrified and sits on the sidelines. So there is a huge imbalance between buy side and sell side.

Meanwhile, media hype about massive defaults inflicts psychological damage on the investors who might otherwise want to buy tax-free bonds. So they are frozen like a deer in the headlights.

At Cumberland, we find this period to be one of the great bond buying opportunities of a generation. We are able to “cherry pick” the tax-free Muni landscape. Unlike the Chicken Little forecasts that paint a market of 90,000 separate items as if it is homogeneous, at Cumberland we examine each credit and screen out the Harrisburg and Vallejo trash. We did not buy them and would not own them.

But we would buy and do own tax-free Muni credits like the NJ Turnpike, San Diego airport, Nebraska housing, and Chicago Met Pier.

So Meredith, we challenge you. We have named names of Munis we hold for clients and where we believe there will be no default. Let us hear the names of those that you say will default. Surely, you can offer examples to back up your assertions about “50 to 100 cities.” Let us compare facts and CUSIP numbers and bond indentures instead of innuendo and assertions and hype.

We return from the GIC meeting in Santiago on Monday night and expect to be in the office by Tuesday afternoon.

David R. Kotok
Chairman and Chief Investment Officer
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