The Tycoon Report

Muni Money ...

Monday, June 4, 2007 | Jason Jovine

I know that you are used to my giving you stocks and the occasional bond idea(s), and I love giving them to you, but after watching the wheels of the market go round and round lately, I wanted you to open your mind to other places to put your money.

GDP (Gross Domestic Product), which is the total value of all goods and services produced in an economy, was announced last week for the first quarter of 2007; the number came in at 0.6% ... below what Wall Street had been expecting.

The unemployment rate remains at 4.5% in the US, and personal spending is up, although personal income is down; this data came out on Friday (June 1, 2007).  Consumers generally feel happy, so they are spending.  Two consumer confidence figures came out last week, and they were fairly strong.

So consumers, whose spending makes up about two-thirds of the GDP, have been generally spending and having a jolly old time.  Can you relate?

It seems that the market has been hitting highs almost every day, and most people have jobs. The challenges right now, of course, lie in the real estate sector, in gas prices that are creeping back up (oil closed at over $65 a barrel on Friday), and in inflation, which still remains above the Fed's comfort level, a fact which could lead to higher interest rates.

June 1 was the first official day of hurricane season, which could send the price of oil even higher, and when oil prices and gas prices increase, the prices of everything in the economy increase as well; in other words, inflation.

On the demand side, the summer driving season obviously increases the demand for oil and gas, and that will also propel prices higher. 

Wall Street is also usually dead in the summer.  Brokers, traders, and investment bankers like to make their money when the weather in New York is crappy (which is most of the time) and spend it when the weather finally becomes decent (in the summer).

They may drive their Ferraris to the Hamptons or some other place where they can hang out with other rich idiots.

Back to business ...

One thing that I have learned the hard way is that parties don't last forever.  In other words, the market has been hitting a lot of new highs lately, but that will not continue forever.  As a matter of fact, the bartender for this party may shout out "last call" before we know it.

That said, the name of the game, if you didn't know, is to always put your money in a place which has the most return with the least amount of risk.  The stock market has been that place for a while now. 

As most of you know, real estate was the place several years ago.  I remember like it was yesterday a mortgage broker friend of a friend of mine rubbing in my face how well he was doing.

The stock market was not doing that well back then; now it is the other way around.  The difference between him and me is that I wouldn't rub it in his face in it if I were doing better than he, because I know that everyone will have ups and downs.  You may be on top today but on the bottom tomorrow, and much of it is not in our control.

Before I go further, I just wanted to clarify that I am not saying to go out there and sell all of your stocks today.  I am simply saying that I believe that the market will soon take a breather, and to scale back a bit on some of your riskier positions (not your core holdings, the solid companies that you have been holding for a while) and to consider putting some of that money in Muni Bonds.

OK, Jason, what is a Muni Bond?

Well, when state or local governments need to raise money, they issue municipal bonds (munis).  The local government units that can issue muni bonds include cities, counties, school districts, etc.

Why would I want to buy a muni bond?

Well, I'm glad that you asked.  Besides the reasons that I mentioned in the beginning of this article are the tax advantages of muni bonds.  Muni bonds are exempt from federal taxes.  This exemption was a result of a Supreme Court decision that the federal government and the municipal governments could not tax the interest on one another's debt.  Moreover, most states also exempt interest from bonds issued WITHIN THEIR STATE from a resident's state and local income taxes.

For example, a resident who lives in, say, California who invests in CALIFORNIA municipal bonds would not need to pay federal, state, or local taxes on the interest earned.  However, if a state resident earns interest from an out-of-state municipal security, that interest is usually subject to taxation.

Generally speaking, BUY MUNI BONDS FROM THE STATE THAT YOU LIVE IN!!!

OK, Smarty-Pants, what types of munis are there?

There are generally two types of muni bonds:  General Obligation Bonds (GOs), and revenue bonds.  The difference between the two is that a general obligation is just that -- a general obligation of that municipality.  A revenue bond, on the other hand, will pay you the interest and the money back on that bond from the revenue derived from the project that the money was raised for in the first place.

For example, one of the reasons that you may pay a toll going over a bridge or through a tunnel is to repay revenue bondholders.  There are also municipal notes which are shorter term in nature and beyond the scope of this article.

What are the risks?

Just like any other bond you buy (e.g. a corporate or US government bond), risk and reward go hand in hand. 

The quality of the issuer is an important factor.  If you buy a revenue bond, for example, for a project in Nowheretown, California, you would probably expect it to be riskier than if you bought one from Beverly Hills.  But then again, with the Nowheretown revenue bond, you would get a higher coupon payment (yield) to compensate you for this risk.

Maturity is also a factor.  How long before they pay you back your money?  There are other factors but these are the real ones to think about.  Generally speaking, muni bonds in the US are fairly secure.  Again, generally speaking.

Who should buy muni bonds?

The short answer is everyone. 

The longer answer is that since they are exempt from federal taxes, the people who will derive the most benefit from them are those who are in the highest tax bracket.  In other words, the higher your tax bracket, the greater the benefit that you will derive from this type of investment.

For example, an individual in the 28% bracket purchases a 9% muni bond at par ($1,000 per bond).  The individual would need to earn 12.5% on a fully taxable instrument (such as a corporate bond) to equal the tax-free yield on the muni bond:

Taxable Equivalent Yield=                          9%
                                                ______________________

                                                     100-28% tax bracket


                                        =                           9%
                                                          _____________
               
                                                                   72%   

                                        =                      12.5%



If the individual had been in the 35% tax bracket, the same 9% muni bond would have a taxable equivalent yield of 13.85%. Try the math on your own.  

This example clearly shows that the same bond is more attractive to an individual in a higher tax bracket.

Net Yield

Since the interest on a corporate bond is taxable, the investor would realize a lower net return (after taxes).  To determine the net yield of a taxable investment, the formula is:

Net Yield = Taxable Yield x (100% - tax bracket)

For example, an individual in the 28% tax bracket purchases a 12% corporate bond at par ($1,000 per bond).  After taxes, the investor earns 8.64%, calculated as follows:

Net yield = 12% x (100% - 8%)
               = 12% x 72%
               = 8.64%


A muni bond would need to yield 8.64% to be equivalent to this corporate bond.

Mr. Jovine, where can I get more info?

Thank you.  I think that I like 'Mr. Jovine' better than 'Jason', but then again, it makes me feel older.  For starters, you can go to the bond section of Yahoo finance (http://finance.yahoo.com/bonds).

Here are a couple of other decent sites:


     Municipal Securities Rulemaking Board:  http://www.msrb.org/msrb1/

     Investing in Bonds.com:  http://www.investinginbonds.com/


Until the next time, folks, spend your hard-earned money wisely,

               





Jason Jovine
Contributing Editor
The Tycoon Report



Monday, June 4

10:00 - Factory Orders (for April): Consensus 0.6%

Big Picture: Volatile factory orders peaked in September, but are rebounding.  The struggling auto and housing sectors add to the softening in business capital investment, as orders and production are back on the rise.  Some of the falloff was due to the drawing down of unwanted inventories as the correction seems largely over.  The underlying fundamentals of flush corporate balance sheets and high capacity use help support capital investment and factory production.

Implications: Factory orders consist of the earlier announced durable goods report plus non-durable goods orders.  The report is very predictable, with nondurables the only new component.  Nondurables consist of such items as food and tobacco products which grow at a fairly consistent monthly rate, so that market forecasts for this report are far more accurate than for the durable orders report.  In addition to seeing nondurables for the first time, the market also watches for revisions to the durable orders data, which can be significant.  At present, durable goods orders sum to about 54% of total orders.


Tuesday, June 5

10:00 - ISM Services (for May): Consensus 55.0

Big Picture: The non-manufacturing ISM report is a national survey of purchasing managers which covers new orders, employment, inventories, supplier delivery times, prices, backlog orders, export orders, and import orders.  Diffusion indexes are produced for each of these categories, with a reading over 50% indicating expansion relative to the prior month, and a sub-50% reading indicating contraction.

Implications: The Non-Manufacturing ISM index (sometimes refered to as the ISM Service index) is the result of a monthly survey of over 370 companies.  The survey queries respondents on a number of monthly indicators, including orders, employment, inventories, supplier delivery times, prices paid, order backlogs, export orders, and import orders.  Respondents are asked to characterize each indicator as higher, lower, or unchanged for the month (or faster/slower in the case of delivery times).  They are not asked for specific numbers -- only a thumbs up or down.


Thursday, June 7

8:30 - Initial Claims (for 6/02): Consensus NA

Big Picture: Initial claims had been following a subtle upward trend, which has again been challenged with the recent levels.  Aberrations are watched for clues on the labor market and economy as the recent level reflects an even tighter labor market.  Continued claims are also falling off their recent highs.   Claims provide a nearly real time read on layoffs and the labor market, as the low 4.5% unemployment reflects the broader read of layoffs and hiring.

Implications: Initial jobless claims measure the number of filings for state jobless benefits.  This report provides a timely, but often misleading, indicator of the direction of the economy, with increases (decreases) in claims potential signalling slowing (accelerating) job growth.  On a week-to-week basis, claims are quite volatile, and many analysts therefore track a four week moving average to get a better sense of the underlying trend.  It typically takes a sustained move of at least 30K in claims to signal a meaningful change in job growth.

10:00 - Wholesale Inventories (for April): Consensus 0.3%

Big Picture: Wholesaler inventories growth of 8% yoy is now just below the annual growth in sales.  The inventory to sales ratio is back down at 1.14 months, not far from June's 1.12 month record low as we expect it to return to (or below) 1.12 months in 2007.  Longer term trends reflect  comfort at those I/S lows as technology allows for continued improvement in just-in-time inventory management.  The smaller inventory swings from rebuilding and draw downs leaves a steadier pace of domestic growth.

Implications: The wholesale trade report includes sales and inventory statistics from the second stage of the manufacturing process.  The sales figures say close to nothing about personal consumption and therefore do not move the market.  Wholesale inventories sometimes swing enough to change the aggregate inventory profile (aggregate inventory is the sum of inventory at the manufacturing, wholesale, and retail levels), which may affect the GDP outlook.  In that event they can elicit a small market reaction.  More often than not, however, this release goes unnoticed except by market economists.

15:00 - Consumer Credit (for April): Consensus $6.0B

Big Picture: Tax cuts and cash out mortgage refinancing provided consumer funding in past years, as 6% yoy income growth and equity gains now provide the means outside of credit.  Credit cards (revolving credit) make up 37% of total consumer credit, which stands at $2.4 trillion.  Nonrevolving credit helps finance auto purchases, tuition (including Sallie Mae), vacations and other forms of consumer borrowing.  Annual growth of 5.2% has shown acceleration from the 3.4% yoy decade low a year ago.  Consumer credit includes household non-mortgage loans.

Implications: This monthly measure of consumer debt is volatile and subject to massive revisions.  It is also released well after every other consumer spending indicator, including weekly chain store sales, auto sales, consumer confidence, retail sales, and personal consumption.  For these reasons, the market almost never reacts to the consumer credit report.


Friday, June 8

8:30 - Trade Balance (for April): Consensus -$63.0B

Big Picture: The swing of petroleum import prices mask the weakening domestic demand for foreign goods, as the weaker dollar and economy slowly provide the force.  Exports feed a stronger world economy and have shown six new record highs over the last eight months.  From a year ago, exports have risen 9% as imports have risen 7%.  Import growth carries a larger effect as they are about 50% larger than exports.  China commands roughly a third of the deficit, as petroleum also amounts to about 1/3.  The massive size of the deficit is eyed for effects on the dollar and interest rates.  The trade deficit demands an equal but opposite investment inflow from abroad as current foreign demand remains exceedingly strong given the return of petrodollars and Asian demand.

Implications: The trade report is most widely watched for trends in the overall trade balance, but trends in both exports and imports of goods and services bear watching as well.  The export data in particular are important to watch for indications that a strengthening competitive position at home and/or strengthening economies overseas are boosting U.S. growth.  Imports provide an indication of domestic demand, but given the severe lag of this report relative to other consumption indicators, it is not particularly valuable for this purpose.  The volatility in the monthly trade balance can play an important role in GDP forecasts.  Net exports are a relatively volatile component of GDP, and the trade report provides the only early clues to the net export performance each quarter.


Source:  www.Briefing.com