Last Friday, we attended a risk management conference organized by the Global Interdependence Center at the Philadelphia Federal Reserve Bank. One of the speakers was Tom Kozlik, a municipal credit analyst for Janney Montgomery Scott. Mr. Kozlik has appeared as a guest on CNBC, Fox Business and Bloomberg News programs. Mr. Kozlik presented what we consider a well-rounded description of municipal finance at the present time.
To see a list of high yielding CDs go here.
Mr. Kozlik sought to calm some of the more irrational fears gnawing at fixed income investors, but also expressed concerns regarding parts of the municipal universe. Mr. Kozlik made the following points:
- There has been too much focus by investors on “outliers”, such as Detroit and Puerto Rico.
- About half of all municipal debt is rated in the AA area.
- A-rate and AA-rated combine to make up about more than 80% of municipal credit.
- Corporate debt issuance is heaviest in the BBB to B range.
- Municipal defaults are lower than in the 1980s.
These are all positives for the municipal market. However, not all is rosy in municipal credit:
- Municipal credit quality has declined a bit (albeit by the percentage of AA declining slightly as the percentage of A-rated debt increased slightly).
- Most defaults have been housing and healthcare related.
- U.S. state tax revenues have fallen while pension and OPEB expenses have increased.
- As states get squeezed, they could cut resources to local municipalities to make ends meet. Local G.O.s could come under pressure.
- A trend of aid cuts rather than tax revenue increases could become entrenched among states.
- Tax increases could be used as a “last resort.”
- Narrowing of state reserves could become a problem (Texas and Alaska reserves make up approximately half of total state reserves in the United States)
Mr. Kozlik provided data and opinion regarding which states have positive or stable outlooks and which states have negative outlooks. However, he emphasized that credit risks are greater at the local level. He provided data which indicate that local government revenues are “not trending close” to pre-2010 levels.
Prices of U.S. Treasuries are modestly higher yesterday after Existing Home Sales and Chicago Fed data disappointed as well as disappointing developments out of Japan and China.
Sales of existing homes fell 1.8% in August versus a prior revised 2.2% (down from 2.4%) and lower than the Street consensus estimate of 1.0%. Existing Home Sales ran at an annual pace of 5.05 million in August, down from a prior revised 5.14 million (down from 5.15 million) in July. The National Association of Realtors data indicate that slow wage growth is and credit conditions are “tight.” Prospective home buyers are not having an easy time of it. Data also indicated that real estate investor activity slowed in August. The disappointing data has some economies worried that the real estate market is running out of steam.
Some economists have been hopeful that banks would loosen credit standards. However, other than some loosening at the margins, lending standards remain much tighter than what they were during the housing bubble. We counter that they do not appear tighter than the lending standards seen prior to the housing bubble.
If the economy needs lax lending standards to grow, it would appear that there is something fundamentally wrong with its construct. An economy which relies on home construction for growth is structurally impaired as one cannot expect to have a permanent baby boom and/or to rely on population growth for economic vibrancy. However, economists and policymakers have become spoiled for the last 58 years.
Population gains and having the largest segment of the population in its peak earning years has set a very high bar for growth and consumption expectations in the United States. If you are waiting for housing to drive the economy, you might as well join Linus in waiting for the Great Pumpkin. Policymakers and economists who see housing as the main solution for economic malaise should probably step aside to let new thinking prevail.
Chicago Fed National Activity data indicate that the U.S. economy slowed a bit in August. The Index came in at -0.21 versus a prior 0.26 (down from 0.39) and a Street consensus estimate of 0.33.This was the lowest print since weather-plagued January (-0.8557). Prints below 0.00 indicate “below average” growth. The report indicated: The decline was led by the production-related component which tumbled to -0.17 last month from +0.24 for the prior month. Manufacturing production fell 0.4% in August after rising 0.7% in July, while manufacturing capacity utilization declined to 77.2% from 77.6% over the same span. The components for sales and consumption ticked slightly higher, while employment-related indicators remained flat. The three-month average (a less volatile measure) remained positive, coming in at +0.07 in August from +0.20 in July.
August Chicago Fed data indicate that the U.S. economy might continue expanding, but it might not attain so-called escape velocity.
Do you think it’s Alright (to leave the economy with central bankers)?
Overseas economic data and comments made by foreign policymakers indicate that central bankers might not be able to lift economies going forward. China’s Finance Minister, Lou Jiwei, damped speculation the government will boost economic stimulus. Mr. Lou said the government will not make major policy changes in response to economic indicators, after data last week showed foreign direct investment dropped to a four-year low. In the long run, this could be good for China as it addresses potential asset bubbles and capital dislocations. In the near term, China’s willingness to allow its economy to slow might not be good for investors who have significant exposure in Chinese assets.
ECB President, Mario Draghi, put a damper on expectations that the worst might not be over for the Eurozone. Mr. Draghi said that the risks to the Eurozone “are clearly on the downside. “He said that recent indicators gave no indication that the sharp decline in economic activity in the region has stopped.
Mr. Draghi went on to say: “We expect inflation to remain at low levels over the coming months before increasing gradually in 2015 and 2016.” He also stated that policy makers will “focus in particular on repercussions of damped growth dynamics” and “closely monitor risks to price stability.”
We have said it before and will say it again: Europe is a mess. The effectiveness of monetary policy must be judged within the context of fiscal policy and economic fundamentals. When the Eurozone’s underlying fundamentals are considered, it appears as though aggressive monetary policy accommodation might be needed just to prevent the economy from contracting. As such, we believe that European sovereign debt yields could be well anchored for a long time. When considering European investments, we prefer corporations which have significant exposure to the U.S., UK and Canada.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
Director of Fixed Income
Wealth Strategies & Management LLC