Fraud is as old a risk as any,but there are now other concerns
about muni bonds, some old, somenew.
False Assumptions about Muni Defaults
Is the default rate of munibonds 0.6% or not? Well, it
depends onwho you ask.
If you ask the ratings agencies,they would agree with the 0.6%
historical muni bond default rate. Their data suggests that
only 47municipalities defaulted between the years 1986 to
2011. But this number is based solely on thosebonds the
ratings agencies actually rate.
We also should keep in mindthese are the same ratings agencies
now being sued for "misleading" what they reallyknew about the
housing market in 2006. Isit also possible some of the highly
rated municipal bonds are actually riskierthan their ratings
imply? You betcha.
What the Fed Said
If you ask the FederalReserve, they suggest the default rate is
much higher. Their 2012 report shows 2,366 defaults in
thesame period. This amount of defaults is
50x more than the ratings agenciesimply. To be fair, their
sample size isalso a lot larger making the actual default rate
assumption from the Fed more around4%. But even so, the Fed's
data shows a 7x higher versus historical data
published by the ratings agencies.
In an article titled, "
Municipal Bond Defaults are Higher than
," we highlighted some of these very points. Why should we
Because, as we outlined in theETF Profit Strategy Newsletter
released 7/20/12 when MUB was trading at $110,
"Conservativeinvestors should avoid the munibond sector. For
aggressive traders, a shorting opportunity will come, but only
afterthe market technicals first confirm that it's time to do
so". By the way, the MUB is still trading aroundthat $110
price, and now the charts may bealigning with the negative
What the Charts are Saying
Over the longer-term, municipalbond rates remain near 50 year
lows as the Federal Reserve chart shows. Butthis may be changing as
cracks are starting to form in the foundation of the
In our ETF Technical Forecastprovided 3/10/13 we stated, "Keep
an eye on the (NYSEARCA:MUB) and (NYSEARCA:HYD)indices as we have
been talking about the coming disaster in muni bonds forawhile now,
and these charts may be the first signs of a longer-term change
intrend for munis. A breakdown of MUB mayput that trade on
the map." In the chart below the iSharesS&P National
Municipal Bond Fund is shown over the past 5 years and shows
the recent weakness inMUB.
We also provided a short-term tradewith a Reward:Risk ratio of
over 3:1 for HYD.
The first thing to notice isthe previous declines of the index
have not encroached into the price territoryof the previous
peaks. In 2008 munibonds sold off from the $87.5 level and
then recovered making a new high at$99. The ensuing pullback
then heldabove $87.5 into 2011. The next declineoccurred at
the beginning of 2012. Thispullback too did not reach the
previous peak at $99.
The latest pullback, though,has now breached that $110 previous
peak. This is coupled with declining momentum shown in the
bottomsection. None of the previous peaks wereassociated with
such loss of momentum and this is a warning.
The fundamental risks havebeen in place for awhile, now we are
just waiting for the technicals to confirmthe top, which may indeed
be occurring now.
ETF Technical Forecast