One day Ben Bernanke and President Obama were driving through Detroit in a GM car when all of a sudden they were scared by…
Okay… skip that. I don’t know any joke that starts that way, but it sure sounds like one!
But the combination of Bernanke, Obama, Detroit and fear has produced not a joke, but a gift, as long as you’re willing to accept it. The problem with this gift is that it takes a little digging and some strong convictions, but the payoff is well worth all the effort!
President Obama began to develop this gift by pushing for higher taxes.
It’s no secret to anyone in the U.S. that, at the beginning of this year, the president and Congress passed a law raising taxes on millions of Americans on earned income, dividends, and interest.
This served as a wakeup call to all of us that the problems of the U.S. deficit and debt, right or wrong, will be at least partially offset by taking more from those who earn and invest.
How is this a gift?
It’s a gift because it brought into sharp focus that all of us should be paying close attention to how we can shrink our taxable footprints.
As for Bernanke, he has spent the last five years stealing money from savers at a clip that makes Bernie Madoff look like a bully on an elementary school playground.
Ben has held short-term interest rates at near zero and forced longer rates to unimaginably low levels while inflation runs between 1.5% and 1.7%. This means that anyone using fixed income securities to save and grow their wealth has been losing ground on all but the riskiest or longest maturities.
Well… no more.
While this is an obvious statement (they couldn’t stay forever), the fact that they finally said as much, and that there was some timing attached (later this year or next year), sent shivers through the fixed income markets. It drove interest rates up at a rapid pace, causing bonds of all stripes to lose value.
When something loses value, we as investors must take some time to evaluate the reasons why.
Is the loss justified?
Is it long term?
Is it overdone?
Considering that the Fed has simply stated the obvious, and that the economy has not recovered anywhere near what the Fed has said is required before it totally exits the markets, it looks like bonds are setting up for a nice rebound.
Which brings me to Detroit…
Motor City is not in bankruptcy, but the Emergency Manager of the city has threatened to go down that road if the city’s creditors – vendors, bondholders, unions and all – don’t agree to a restructuring.
This is just the latest example of a city holding a press conference to confirm what everyone knows. Cities can, and do, go bankrupt. They leave behind a lot of unpaid bills and broken promises, including the promise to use their full faith and credit to pay back those who lent them money, namely bond investors.
On this news from Detroit, bonds issued by the city, as well as bonds issued by other cities in similarly dire straits, sold off.
This leads to the real gift for investors with an iron stomach…
Higher interest rates and a fear of cities not paying their debts led to a fall in the value of municipal bonds in general. Remember, this is going on exactly when the tax rates of higher income earners and investors have moved up, which means municipal bonds provide even greater shelter from taxes.
The problem is that municipal bonds were always a sleepy corner of the financial world, reserved for those that wanted safe, boring investments. Because there is turmoil in the municipal bond market right now, the typical muni investor is being scared away. Last month, investors pulled billions of dollars from municipal bond funds.
That giant sucking sound is creating a vacuum as prices fall and interest rates shoot higher, setting up an opportunity for the rest of us to step in and pick up some interest income that is shielded from taxes.
Over the next several weeks and maybe months we expect that investors will get a chance to buy municipal bonds and bond funds at very attractive rates, allowing them to earn substantial tax-free yield for years to come.
The problem of course is that the muni market is weird. Each issuer has its own peculiarities. The different vehicles available for investing in this market can be confusing.
It’s not often that any of these players give something to the individual investor… we’d better take advantage of it while we can!
Ahead of the Curve with Adam O’Dell
We first recommended buying this fund in the summer of 2011. Our Boom & Bust model portfolio grabbed a double-digit gain in this fund early last year.