March 13, 2008
In addition to the normal
components used in the process of evaluating municipal
bonds, two additional and very important factors exist
in the municipal bond market. Those two factors
are the consideration of current levels of interest
rates and the perceived risk stemming from mortgage
backed securities and municipal insurance companies.
First of all, most of us
realize that the FOMC is focused primarily on growth at
this time and secondarily on inflation. With that,
most of Wall Street expects the FOMC to be accommodative
near-term if they need to be. However, most of
Wall Street also understands that the interest rate cuts
that are taking place now will be reversed once the
economy starts to be gain traction. That means
interest rates are low respective to where they are
likely to be six months or a year from now. In a
normal market environment the inverse relationship
between interest rates and price tells us that muni
prices, everything held constant, are likely to decline
when the recent interest rate cuts are reversed out of
the market.
Second, the risk factor
associated with municipal bonds is serious enough to
make municipal bonds comparably attractive in today's
market environment. Again, everything held
constant, if an investor was able to identify a bond
issued from a municipality that had significant debt
coverage a value would be identified higher market
values would be warranted for those bonds when the
current environment improved; a value opportunity would
present itself. In many separate instances this
exact scenario probably holds true, and therefore there
are probably many comparative value options in this
market, everything held constant. Municipal bonds
may be beaten up too much based on the problems facing
Ambac (ABK), Fannie Mae (FNM), MBIA (MBI),
and the others, and when the problems with these
insurers work their way through the system a valuable
arbitrage player would assume that bonds with high debt
coverage would increase in value.
Conjoined, the first and
second points mentioned above create a balanced risk
environment, and the value added proposition is diluted.
Because municipal bonds already have comparably higher
yields due to risk one might think that price
appreciation lies ahead. However, if Interest
rates reverse too, all bets are off.
The value proposition may
be, if you're going to buy any bonds buy municipal bonds
because their prices are likely to be much more stable
than other bonds given the interest rate landscape that
lies ahead of us. However, if you are looking for
anything else from this equation you may be barking up
the wrong tree. Municipal bonds are not likely to
increase in value once inflation becomes more of a
priority to the FOMC.
Good Trading
Stock Traders Daily
http://www.stocktradersdaily.com
1.866.213.2067
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