From MorningstarAdvisor

by Russel Kinnel | 07-18-11

What happened to the muni catastrophe? Meredith Whitney ended 2010 scaring the daylights out of municipal-bond investors by predicting “hundreds of billions” in municipal-bond defaults in the coming year. No doubt her prediction on “60 Minutes” played a part in the net redemptions seen in municipal-bond funds for most of this year.

Yet here we are at the halfway point, and defaults are running at a trickle. Rather than the $200 billion or more of defaults Whitney predicted, we’ve had $746 million according to Income Securities Advisor. DWS estimates that, at that rate, we’ll have about $1.7 billion in defaults for the year. In fact, DWS and Income Securities Advisor’s Distressed Debt Securities newsletter say defaults have dropped significantly from the prior three years. The market peaked at about $8 billion in defaults in 2008, so this year could be one fourth of that or less.

For those scoring at home, that means we’ve only reached 1% of Whitney’s predicted default level.

You’ve no doubt read about the problems in Illinois, Florida, and California, where deficits have grown and governments have been forced to make cuts. But there are good reasons why the system is strained but not breaking. Governments can raise taxes and cut spending to get themselves out of their messes, and that’s what they are doing. Moreover, they need to come back to municipal markets to continue to borrow so they have strong incentives to treat bondholders well.

In addition, an improving economy has meant rising tax revenues. Municipalities’ tax revenues started rising in late 2010 and have continued to do so. Income tax and sales-tax revenues naturally rise as the economy improves.

This means that, if you own a well-run muni-bond fund, you’re in pretty good shape. These funds usually have bonds from a hundred or more issuers, so one default won’t have much impact. And, of course, they do thorough credit research to steer clear of most, though not all, defaults. With some munis paying better tax-free yields than many high-quality taxable bonds, this isn’t a bad time to get in. In fact, some taxable-bond managers are even buying munis because they look attractive even without the tax break factored in. That said, fewer new munis have been issued so far in 2011, so additional waves of new debt could drive prices lower in the short term.

Investors may have noticed the divergence between dire predictions and reality as muni-fund flows turned positive in June after fairly steady redemptions. The $980 million flowing into munis isn’t a huge amount but it does indicate that the fear level is dropping. I don’t expect this to turn into really big inflows soon, but it may mean a market headwind is going away.

I respect New York Times commentator David Brooks for his well thought out columns.  His appearances on Sunday talk shows always provide calm clear analysis.  This is what he said about the 2008 economic meltdown.

It all started with Fannie Mae, the government-backed mortgage giant, and its former chief executive James Johnson. In a well ­reported new book, Reckless Endangerment, Gretchen Morgenson and Joshua Rosner reveal how Johnson, a “Democratic sage with a raft of prestigious connections,” enriched his friends and made $100 million for himself by flooding the market with risky subprime mortgages. Dispensing with the usual criteria for making loans, Fannie handed out billions in federally guaranteed dollars like candy, and “helped spread risky behavior and low standards across the housing industry.” Johnson and his cronies paid themselves lavishly, and used Fannie funding to lobby congressmen, falsify academic research, and suck in “reputable figures” such as Bill Daley, Ken Starr, and Larry Summers to defend Fannie’s scam. In the end it all crashed-bringing big banks, Wall Street, and the entire economy down with it. Yet Johnson and the other power players skated away, blameless. “This is how Washington works.” Is it any wonder there’s such a growth market for angry populism?

In January 2010 we all saw the stock market dip, rise and dive.  At the end of the month there was no appreciable change from January 1.  I offered the historic fact that January’s are a worthwhile bell weather forecaster of the entire year.  I was wrong and the market grew dramatically month after month.  I threw in the towel in December 2010 and joined the obvious surge in stock market values.  The decision was reinforced this past January.  However, I have continued to be sceptical because I see no reason for optimism in the United States.  Brazil, China, and India are growing because the West has outsourced its manufacturing.

David Rosenberg of the Financial Times supports my view with some valuable observations.

There’s no denying we’re in the midst of an “incredible” stock-market rally, said David Rosenberg. But that doesn’t mean we’re in a bull  market. Genuine bull markets are preceded by demographic shifts or technological advances that promote rapid, sustained growth in productivity and capital assets. The 1949-66 bull market was spurred by “a baby boom that would unleash years of tremendously strong demand growth.” The 1982-2000 bull run was powered by “a wave of innovation” that brought us the mainframe, the personal computer, the Internet, and the smartphone. By contrast, the “bear-market rally” of 2003-07 was fueled by “phony wealth generated by a nonproductive asset called housing,” with a dubious assist from “widespread financial engineering.” Likewise, the current rally doesn’t owe its existence to the iPad or Facebook. They’re “fun,” but they haven’t revolutionized productivity. What has fueled the rally is “unprecedented monetary and fiscal stimulus.” Granted, it’s tough to sit out a rally that has seen “the market surge more than 90 percent.” But “it is much, much tougher to actually experience a correction in the other direction.”

Photo credit: http://photobucket.com/images/crying/?sortby=sevendaysview#!cpZZ2QQtppZZ16

In 1971 I bought my first home for $28,000.  My annual income was $10,000.  I was buying a home within the usual guideline parameters for buying at home 2 ½ to 3 times my annual income.  Excluded was my wife’s income because I knew she would stop working once we had children.  I sold that house in 1979 for $88,000.  I could not afford to buy the house for that price because my salary had tracked the median household income and was $17,000.  I was fortunate and my income did exceed the annual average in the following years. However, it certainly did not rise sufficiently to enable me to afford buying my second home at its market price in 2000 and beyond.   

The U.S. Census Bureau currently publishes median household income data from 1975 until present day.

Year

No. of Households

Nominal $

Inflation Adjusted $

2009

117,538,000

$49,777

$49,777

2008

117,181,000

$50,112

$50,112

2007

116,783,000

$50,233

$52,163

2006

116,011,000

$48,201

$51,473

2005

114,384,000

$46,326

$51,093

2004

113,343,000

$44,334

$50,535

2003

112,000,000

$43,318

$50,711

2002

111,278,000

$42,409

$50,756

2001

109,297,000

$42,228

$51,356

2000

108,209,000

$41,990

$52,500

1999

106,434,000

$40,696

$52,587

1998

103,874,000

$38,885

$51,295

1997

102,528,000

$37,005

$49,497

1996

101,018,000

$35,492

$48,499

1995

99,627,000

$34,076

$47,803

1994

98,990,000

$32,264

$46,351

1993

97,107,000

$31,241

$45,839

1992

96,426,000

$30,636

$46,063

1991

95,669,000

$30,126

$46,445

1990

94,312,000

$29,943

$47,818

1989

93,347,000

$28,906

$48,463

1988

92,830,000

$27,225

$47,614

1987

91,124,000

$26,061

$47,251

1986

89,479,000

$24,897

$46,665

1985

88,458,000

$23,618

$45,069

1984

86,789,000

$22,415

$44,242

1983

85,407,000

$20,885

$42,910

1982

83,918,000

$20,171

$43,212

1981

83,527,000

$19,074

$43,328

1980

82,368,000

$17,710

$44,059

1979

80,776,000

$16,461

$45,498

1978

77,330,000

$15,064

$45,625

1977

76,030,000

$13,572

$43,925

1976

74,142,000

$12,686

$43,649

1975

72,867,000

$11,800

$42,936

Home prices have not kept pace with median family income for most people.  We saw an unrealistic acceleration that was boosted by the government and home loan companies.  From the Business Insider comes this graph created by economist Robert Shiller that supports my contention that the housing bubble will not be inflating any time soon.

Click on graph to enlarge

I remember when my mother came home with a “charga-plate” from the May Company department store.  That was back in the 1950s and really was the beginning of the charge card era.  Charge cards and easy credit has been a big boon for retailers of all sorts.  From cars to clothes to food, we can now buy everything using that plastic card.  

Newsweek’s December 6, 2010 cover is titled Money to Burn – Why Americans Can’t Stop Spending.  The article contends that our spending habit and instant gratification culture will dominate our knowledge that the bill for all that spending will arrive at the end of the month. 

Despite the persuasiveness of that argument there is definitely a rising tide of those who have learned that you can’t have everything you want.  The Dave Ramsey radio program contends that “Cash is King and the Paid off Mortgage has replaced the BMW” as the new American idea of success. His three hour program seems to be in every part of the country from Portland, Oregon to Los Angeles, California to Nashville, Tennessee totaling over 350 outlets.

Now the “Great Recession” seems to have brought us to our senses.  Most of us have lost a job or know someone who has.  All of us have been alerted and frightened by that growing credit card debt.  The recession now denies us, what seemed the never ending offers to apply for more credit cards and easy credit terms.  Most of that has stopped.  According to a Businessweek October 2008 article credit card debt had reached $950 Billion.

From Creditcards.com

• Total U.S. revolving debt (98 percent of which is made up of credit card debt): $852.6 Billion, as of March 2010 (Source: Federal Reserve’s G.19 report on consumer credit, March 2010).  That is a reduction of $50 Billion a year for the past two years.

 

• Total U.S. consumer debt: $2.42 Trillion, as of June 2010 (Source: Federal Reserve’s G.19 report on consumer credit, August 2010)

 

Despite the reports of improved sales in the malls since Black Friday, I believe that our big spending days are behind us.