MUNI BOND BOND EXPOSURE – WARNING

This article by investment expert Jeff Christenson was originally published in this month’s issue of WORTH magazine. It sheds light on how the economy and depressed tax revenue threaten the value of Muni Bonds, what many consider to be the safest part of their portfolio. A must read for advisors, investors and CPAs. – Ike

As State Budgets Troubles Worsen, What’s Next for Muni’s?

A new crisis, that has not yet been addressed, exists within state and municipal
budgets. According to the Center on Budget and Policy Priorities in Washington, DC, an unprecedented level of state fiscal problems have been brought on by the worst decline in tax receipts in decades and these revenue declines show no signs of letting up.

The current recession is expected to be more severe than the last one, causing state fiscal problems to deepen and last longer than previous recessions. At least 48 states are addressing budget shortfalls for fiscal year 2010 totaling $168 billion and an unusual number of these states are still struggling to adopt a budget for fiscal year 2010, two months after the July 1st start date.

These fiscal problems are expected to continue into fiscal year 2011 and likely beyond. At least 36 states are anticipating significant deficits for fiscal year 2011, and these shortfalls are estimated at an additional $180 billion. Combine the shortfalls for the 2010 budget and those estimated for 2011, and the estimated total is at least $350 billion.

Unemployment, which peaked after the last recession at 6.3%, has already exceeded 10%, and many economists expect it to continue to rise. This continued rise in unemployment would further reduce state income tax receipts, thereby significantly increasing demand for Medicaid and other state-provided services. Also, sales tax receipts have fallen more severely than during the previous recession due to a reduction in the consumer’s access to sufficient lines of credit. This reduction in state revenue has forced states to implement a combination of spending cuts, withdrawals from reserves, and use of federal stimulus dollars. When combined with falling property tax receipts due to rising residential and commercial delinquencies and defaults, state and municipal revenues may continue to decline for some time.

Although we see a high level of risk in the municipal bond markets currently, with equity markets rallying, municipal bonds trading at premiums, and more cash moving off of the sidelines and into the markets each day, market conditions may stay positive through year-end or early next year before the sentiment reverses.

Investors who cannot afford to lose their current unrealized gains from the recent rally should be cautious and mindful of the increased risk to capital and strongly consider moving out of municipal bonds to protect capital.

During last year’s financial crisis, municipal bond prices fell by an average of 20%. The current rally has led to a recovery in pricing, with many municipal bonds again trading at premiums. This recovery in pricing is concerning, given the increasing budget shortfalls and the most extensive expense cuts by states and municipalities in history. Given the relatively low yield of most municipal bonds, the ratio of risk to reward seems out of balance. In fact, this may be one of the greatest selling opportunities in history.

Link to the article in WORTH: http://worth.com/index.php/advice?id=168&view=single

Disclaimer:

The views are those of Jeff Christenson and should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Past performance does not guarantee future results.

Securities and Advisory Services are offered through Multi-Financial Securities Corporation, member FINRA, SIPC. Christenson Wealth Management is not affiliated with Multi-Financial Securities Corporation.