PIIG Syndrome Comes To The U.S.: Time To Dump Your Munis

It was only a matter of time.  The PIIG disease has come to this country, infecting the States and municipalities with huge budget defiicts and impossible public employee benefit and pension plans.  Check this out - this is Pimpco's general Municipal Income Fund, with the top 5 State positions noted:

This thing has lost 15.3% since its peak in early September - less than 2 months.  I'd say that fund has trichinosis. If you happen to have a decent portion of your wealth tied up in muni paper, lose sleep assurred that many individual munical issues have lost a lot more, given that the above atrocity is a highly diversified fund, which "shelters" the fund from the ravages of any one individual municipal issuer's disaster.

I got the idea for this post from an article in Saturday's NY Times, which I happened to peruse during my long weekend in La Cittá.  Some imbecile from McDonnell Investment Management tried to explain away the performance of the muni market by "explaining" that the cliff-dive was concentrated among bonds with longer maturities and lower credit ratings.  You can read the NY Times article HERE.

To be sure, longer-dated issues in the muni market have fared worse than their shorter-duration brethren.  But that's a function of duration and correlation with the overall bond market - NOT with credit risk.  As the graph above of a highly divesified muni surrogate illustrates, the PIIG disease is one largely of credit risk, not reinvestment risk. 

The fact of the matter is that wealthy investors - the ones typical of those who invest in munis - piled into the muni market in the insatiable quest of tax benefits.  In other words, a "bubble" developed in the muni market in which prices were driven inexorably higher (and tax-equivalent yields were driven lower) in a frenzy of too much cash chasing after-tax returns and income.  THAT is a bubble.

Please be advised that this is a catastrophe developing that you want to avoid.  At least when a sovereign entity loses its ability to make payments from revenues (i.e. the U.S. Government or an EU satellite country), the sovereign entity can print money to make sure bond payments can be fulfilled.  Not the same with municipal bond issuers.  At this stage in the game, many States are borrowing the money from other sources for now to make payments.  But, as the chart above shows, the perceived risk of default is starting to soar.  As States and municipalities face much higher yields in order to attract yield-hog investors, your existing muni bond portfolio will get crushed.

We all know - that is, "we" who are willingly looking at the reality of the situation - the variables which are strangling the cash flow and budgets of States and municipalities are only going to get worse - a lot worse - as the underlying factors which are squeezing States deteriorate.  And muni paper is typically secured only by the ability of the issuer to fund repayment out of revenues derived from some form of taxation.  As that source of revenue dissipates, so does the value of your muni bond.

If you truly believe that the economy is getting better, then have fun riding your muni bonds into the ground.  But just like the PIIGS, this situation is going to exacerbate. 

Fortunately, there is a solution.  Got gold?