With the turmoil in the markets, a historic shift has been observed in the yield spread on munis, particularly Michigan municipal bonds. Munis are selling at a vast premium to Treasuries on a yield basis. We think this premium is unusual and provides some opportunities. Most notably, we observe:
? There is apparent mispricing of risk in Michigan municipal bonds. The entire market is being painted with one broad brushstroke. Michigan, as I can attest first-hand, is a very diverse state in geography and economy.
? Ratings are helpful, but not determinative. We’re carefully analyzing the issues and the municipalities individually.
? The municipal bond insurers are in turmoil. In fact, many of the insurers are junk rated.
? Tax rates are going up for many investors, and this makes municipal bonds more attractive. Of particular interest is the Health Care Bill, which adds a 3.8% Unearned Income Medicare Contribution tax on dividends, interest and capital gains in 2013. Municipal bond interest is exempt from these taxes also, making the tax-equivalent yield even more attractive to high bracket individuals.
? The current interest rate environment is unique. The yield curve is at a record steepness, and we see opportunity while staying reasonably short as protection against inflation.
? Quality is king. Not all municipal bonds posses the same level of risk, but the market seems to be pricing them that way.
? Liquidity is queen. Municipalities are facing revenue crunches, probably in the magnitude on average of -10- 15% for 2011 and 2012 and possibly longer. They need money and will borrow. We think BABs are a short term solution to the liquidity issue.
? The market is dislocated and somewhat inefficient. We are seeing ‘fire-sale’ prices on some issues. In addition, we see the lack of a central unified market presenting opportunistic buying. We buy on the bid (wholesale) for our portfolios: the spreads tend to be pretty big now.
Leon C. LaBrecque is an attorney, CPA, CFP�, and CFA in Michigan. He is the CEO and chief strategist for the independent wealth management firm, LJPR, LLC headquartered in Troy, Michigan. Together with the firm’s team, he has been analyzing and investing in individual Bonds, particularly Michigan municipal bonds, to the tune of $100 Million.
Please visit http://www.ljpr.com/white-paper-on-michigan-municipal-bonds.html for more information.
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