Is the potential upside in munis worth the downside?

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midareff
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Re: Is the potential upside in munis worth the downside?

Post by midareff »

secondopinion wrote: Mon May 03, 2021 3:00 pm
midareff wrote: Mon May 03, 2021 2:10 pm
secondopinion wrote: Mon May 03, 2021 11:39 am
midareff wrote: Mon May 03, 2021 6:25 am Bonds fluctuate just like stocks and we are in a part of the cycle that has bond NAVs quite extended. A return to the mean for stocks and bonds would be very ugly for either, even a partial return.
We have little choice in the matter; if we knew when the the correction was, then it would have been too late. If you dislike the prospects of return, look at your personal situation and see if there are other personal investments you can make (e.g. more education) or just take some of these gains and make life easier. That is the point of money, is it not?

I am getting more education; it is the best bang for my buck given the circumstances. My taxable account has shrunk, but I do not care; it is my quality of life that counts. It will likely also improve earning potential overtime, and that is an added bonus to the enjoyment of learning.
As far as going to school to improve my education and get a better paying job ... LOL, I'm 73 and ten years retired. As far as your first statement; "We have little choice in the matter;" actually we have lots of choices. Our AA is set by us and we could as much or as little in asset classes as we want. If my life was much easier I'd have to give up the vertical, ambulatory and above top soil parts.
In your case, I guess education to get a better job is probably not worth it. What I mean by "we have little choice in the matter" is that we can neither control or guess what the market will do, nor can we control that both stocks and bonds could both have terrible returns in a correction. I know that the asset allocation is controllable, but I am referring to factors that we just cannot control.
We can't control what the market will do or what the Fed will do. OTOH, we do have control over the impact the Fed has on our bond portfolios
both by what we own and the effective duration thereof. LOL, seeing as I am retired and will stay that way permanently I too guess education for a better job won't be worth it. Then again, decades of continuing education while still in the work place was worth it.
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SquawkIdent
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Re: Is the potential upside in munis worth the downside?

Post by SquawkIdent »

midareff wrote: Mon May 03, 2021 2:15 pm
SquawkIdent wrote: Mon May 03, 2021 11:54 am
midareff wrote: Mon May 03, 2021 6:25 am
canga wrote: Sat May 01, 2021 7:10 pm
midareff wrote: Thu Apr 29, 2021 8:42 am Downside risk is immaterial unless you sell.
I think this is a great point. If your muni-bonds are for buy and hold, then likely the risk is low.

However, I need some bonds available for rebalancing. Selling muni-bonds at a 10% at the start of the pandemic is not a great option, so I aim for no more than 20% of my bond allocation in munis. I can use Total Bond in my 401k as well as Intermediate Treasuries in taxable for rebalancing.
At this point in time I think there are risks for all bond funds due to the potential for inflation and the already low interest rates. Munis are up this YTD and Total Bond is down. I just sold some munis in taxable and blew out a 3.0% 30 year mortgage with 20 years left. The only bad part was having to book $5K in capital gains.

Bonds fluctuate just like stocks and we are in a part of the cycle that has bond NAVs quite extended. A return to the mean for stocks and bonds would be very ugly for either, even a partial return.
+1

Agreed. I’m sticking with my munis. Just getting really, really short term. Collect minimal dividends and waiting for the longer term NAVs to move lower. Then move to longer term and wait for the NAV to recover. Rinse, repeat, rinse, repeat...marketing timing...I guess yes. But it works, every time as long as you have the time and patience to make it work. :sharebeer
Very much agreed..... I've pulled my weighted effective duration down to 3.79 years. Bill Bernstein's short bonds liability matching and the rest equities. Other than that I don't see a place to hide. Warren Buffet acknowledged he seems inflation blooming in all his businesses at his address this weekend.... even the hand car wash just went from $25 to $30 and the local eatery just raised the lunch chicken special by $2. It's here. Rode IT Corporates up 10% last year now in ST. Staying the course doesn't mean hand around to take a beating when it can be avoided.
+1

I’m right with you. I’m going even shorter duration than that. Locking in capital gains from my longer duration investment from a year ago. Only places to hide, that I see, are very short term and cash.
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Re: Is the potential upside in munis worth the downside?

Post by canga »

midareff wrote: Mon May 03, 2021 6:25 am
canga wrote: Sat May 01, 2021 7:10 pm
midareff wrote: Thu Apr 29, 2021 8:42 am Downside risk is immaterial unless you sell.
I think this is a great point. If your muni-bonds are for buy and hold, then likely the risk is low.

However, I need some bonds available for rebalancing. Selling muni-bonds at a 10% at the start of the pandemic is not a great option, so I aim for no more than 20% of my bond allocation in munis. I can use Total Bond in my 401k as well as Intermediate Treasuries in taxable for rebalancing.
At this point in time I think there are risks for all bond funds due to the potential for inflation and the already low interest rates. Munis are up this YTD and Total Bond is down. I just sold some munis in taxable and blew out a 3.0% 30 year mortgage with 20 years left. The only bad part was having to book $5K in capital gains.

Bonds fluctuate just like stocks and we are in a part of the cycle that has bond NAVs quite extended. A return to the mean for stocks and bonds would be very ugly for either, even a partial return.
Treasury funds have performed better than Muni Bond funds in 2008/2009, 2020, and other bear markets. If rising interest rates are a concern then Short Term Treasuries may be preferred.

However, I prefer Intermediate Term Bond funds with a roughly 60/40 portfolio, which historically has had better risk adjusted returns than Short Term. The equity premium over bonds is expected to be the same now as it has historically (4%).

I hold a mixed bag of bonds, so some are bound to lose depending on which way interest rates move (I Bonds, EE Bonds, Total Bond, Intermediate Muni, Intermediate Treasury). Not much choice since I don’t want more than 65% in equities.
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midareff
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Re: Is the potential upside in munis worth the downside?

Post by midareff »

canga wrote: Tue May 04, 2021 12:35 am
midareff wrote: Mon May 03, 2021 6:25 am
canga wrote: Sat May 01, 2021 7:10 pm
midareff wrote: Thu Apr 29, 2021 8:42 am Downside risk is immaterial unless you sell.
I think this is a great point. If your muni-bonds are for buy and hold, then likely the risk is low.

However, I need some bonds available for rebalancing. Selling muni-bonds at a 10% at the start of the pandemic is not a great option, so I aim for no more than 20% of my bond allocation in munis. I can use Total Bond in my 401k as well as Intermediate Treasuries in taxable for rebalancing.
At this point in time I think there are risks for all bond funds due to the potential for inflation and the already low interest rates. Munis are up this YTD and Total Bond is down. I just sold some munis in taxable and blew out a 3.0% 30 year mortgage with 20 years left. The only bad part was having to book $5K in capital gains.

Bonds fluctuate just like stocks and we are in a part of the cycle that has bond NAVs quite extended. A return to the mean for stocks and bonds would be very ugly for either, even a partial return.
Treasury funds have performed better than Muni Bond funds in 2008/2009, 2020, and other bear markets. If rising interest rates are a concern then Short Term Treasuries may be preferred.

However, I prefer Intermediate Term Bond funds with a roughly 60/40 portfolio, which historically has had better risk adjusted returns than Short Term. The equity premium over bonds is expected to be the same now as it has historically (4%).

I hold a mixed bag of bonds, so some are bound to lose depending on which way interest rates move (I Bonds, EE Bonds, Total Bond, Intermediate Muni, Intermediate Treasury). Not much choice since I don’t want more than 65% in equities.
I hold short bonds other than munis as well. I don't think Credit Suisse agrees with you on the 4% premium but nobody has precise forward vision. It will be interesting to see the CPI-U change over the prior month and year on the 12th.
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Re: Is the potential upside in munis worth the downside?

Post by NabSh »

bck63 wrote: Sun Apr 18, 2021 5:50 am
ilan1h wrote: Sat Apr 17, 2021 7:54 pm
bck63 wrote: Sat Apr 17, 2021 7:03 pm
ilan1h wrote: Sat Apr 17, 2021 5:56 pm Many of us, especially in high tax brackets and high tax states, use munis in our taxable accounts as a relatively safe and stable investment option. The downsides of munis have been discussed in great detail and most would agree that munis (specifically national muni bond funds) are generally very conservative investments but not immune from sudden downturns. During the last financial meltdown the national muni funds lost over 20% of their value rather rapidly (compared to 50% stock market losses). Munis also dipped sharply at the beginning of the pandemic. So, in my own mind I am reconciled to potential losses of 20-30% in muni funds in the event of a serious downturn. In the last few downturns the stress seemed more related to liquidity crunches or mechanical market factors than to deep underlying issues and they recovered quickly. However, the upside is more difficult to predict. Right now the yields on these funds are very low and deflation is almost an impossibility with all the spending that we're doing ie: rates will either remain stable or rise. Given all of this, what is the potential upside of munis and is it worth the downsides?
Which national muni mutual funds lost 20% in the most recent downturn? VWITX, which I hold, lost nothing even close to that. I think it was down about 4% at the worst of it. I know ETFs like VTEB had a tougher time of it in terms of bid ask spreads.
Sorry, my bad. The max drawdown for the Long term muni was about 10% from inception. I think that a max drawdown of 10-20% is how I would view it (compared to stock market 50-80%)
I owned some VTEB during the March '20 downturn and it was scary seeing a portion of my intermediate bonds drop so steeply. I waited till it came back up and put it all in a mutual fund, which fared much better.
May I ask which Mutual Fund did you choose to replace VTEB...
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Re: Is the potential upside in munis worth the downside?

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ilan1h wrote: Wed Apr 28, 2021 10:23 pm It seems like there is more and more certainty that inflation is going to rise, perhaps sooner than expected. Many articles appearing from reliable sources that are predicting that the fed will probably raise rates sooner than was previously anticipated. With the astronomical government spending going on it seems almost impossible that rates will stay the same or that they would decline. So if we have close to 100% certainty that rates are going up, are munis still a good investment? I almost feel trapped into munis because I want to avoid stocks, do not have any tax deferred space left, and everything else is yielding nothing.
I'd be cautious about those articles from "reliable sources".

Media has to get you some content to read / watch to get those advertiser dollars.

But if you look at the opinion of big institutions who actually have to vote with their wallets on the issue, the 5 YR breakeven inflation rate is 2.6%:

https://fred.stlouisfed.org/series/T5YIE
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Re: Is the potential upside in munis worth the downside?

Post by midareff »

watchnerd wrote: Tue May 04, 2021 8:42 am
ilan1h wrote: Wed Apr 28, 2021 10:23 pm It seems like there is more and more certainty that inflation is going to rise, perhaps sooner than expected. Many articles appearing from reliable sources that are predicting that the fed will probably raise rates sooner than was previously anticipated. With the astronomical government spending going on it seems almost impossible that rates will stay the same or that they would decline. So if we have close to 100% certainty that rates are going up, are munis still a good investment? I almost feel trapped into munis because I want to avoid stocks, do not have any tax deferred space left, and everything else is yielding nothing.
I'd be cautious about those articles from "reliable sources".

Media has to get you some content to read / watch to get those advertiser dollars.

But if you look at the opinion of big institutions who actually have to vote with their wallets on the issue, the 5 YR breakeven inflation rate is 2.6%:

https://fred.stlouisfed.org/series/T5YIE
Since the rolling 12 month inflation rate is presently 1.18% what does that 2.6% say about interest rates and their impact on bond NAVs over the next 5?
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Tue May 04, 2021 2:18 pm
Since the rolling 12 month inflation rate is presently 1.18% what does that 2.6% say about interest rates and their impact on bond NAVs over the next 5?
It's already part 5 YR bond prices, implicitly.

That's why it's the expected rate....it's already priced in.
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Re: Is the potential upside in munis worth the downside?

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watchnerd wrote: Tue May 04, 2021 3:25 pm
midareff wrote: Tue May 04, 2021 2:18 pm
Since the rolling 12 month inflation rate is presently 1.18% what does that 2.6% say about interest rates and their impact on bond NAVs over the next 5?
It's already part 5 YR bond prices, implicitly.

That's why it's the expected rate....it's already priced in.
I guess we will just have to agree to disagree on that one. IT Treasuries with an SEC of .53% don't have a 2.6% CPI-U factored.
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Wed May 05, 2021 7:01 am I guess we will just have to agree to disagree on that one. IT Treasuries with an SEC of .53% don't have a 2.6% CPI-U factored.
Yes, they do.

They just have negative real yield.

The breakeven inflation rate of 2.6% is derived from the spread between nominals and TIPS.

The breakeven inflation is the expected inflation rate -- by definition it's already factored in, otherwise it couldn't be calculated.

If inflation and interest rates are in equilibrium, then yields and inflation will be in balance, but if you have negative real yields, they won't be.
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Re: Is the potential upside in munis worth the downside?

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watchnerd wrote: Wed May 05, 2021 7:20 am
midareff wrote: Wed May 05, 2021 7:01 am I guess we will just have to agree to disagree on that one. IT Treasuries with an SEC of .53% don't have a 2.6% CPI-U factored.
Yes, they do.

They just have negative real yield.

The breakeven inflation rate of 2.6% is derived from the spread between nominals and TIPS.

The breakeven inflation is the expected inflation rate -- by definition it's already factored in, otherwise it couldn't be calculated.

If inflation and interest rates are in equilibrium, then yields and inflation will be in balance, but if you have negative real yields, they won't be.
Forecasting any future 5 year period is treacherous. The road to accuracy is littered with talking heads who have missed their forecasts time and time again. How they derive their forecast, academically, is immaterial to me. We can revisit this in 5 years and see how close they got.
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Wed May 05, 2021 9:56 am Forecasting any future 5 year period is treacherous. The road to accuracy is littered with talking heads who have missed their forecasts time and time again. How they derive their forecast, academically, is immaterial to me. We can revisit this in 5 years and see how close they got.
Oh, I agree on the difficulty of the forecasting.

But at least this isn't just talk.

Its bond buyers actually voting with their wallets.

This picture illustrates how the expected inflation is built into the bond price that people are paying and how the breakeven rate is derived from the spread between nominals and TIPS.


Image
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Re: Is the potential upside in munis worth the downside?

Post by midareff »

watchnerd wrote: Wed May 05, 2021 11:20 am
midareff wrote: Wed May 05, 2021 9:56 am Forecasting any future 5 year period is treacherous. The road to accuracy is littered with talking heads who have missed their forecasts time and time again. How they derive their forecast, academically, is immaterial to me. We can revisit this in 5 years and see how close they got.
Oh, I agree on the difficulty of the forecasting.

But at least this isn't just talk.

Its bond buyers actually voting with their wallets.

This picture illustrates how the expected inflation is built into the bond price that people are paying and how the breakeven rate is derived from the spread between nominals and TIPS.


Image
I understand how they are voting with their wallets... just like tech buyers voted in 1997/98, and just like market buyers voted in 2007/8. Because someone, or a group of someones, or a whole herd of them vote with their wallet it doesn't mean the desired or expected ending happens. Projections and prognostications are all wonderful things... and occasionally they even turn out. How many years have the talking heads been saying this is the time for International? I only write that as an example of prognostications that have not materialized.

I think I'll do something you will appreciate..... if three years from now inflation is > 2.6% I'll dump my Rolex for a Calatrava.. if not, it stays on my wish list.
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Wed May 05, 2021 3:55 pm

I understand how they are voting with their wallets... just like tech buyers voted in 1997/98, and just like market buyers voted in 2007/8. Because someone, or a group of someones, or a whole herd of them vote with their wallet it doesn't mean the desired or expected ending happens. Projections and prognostications are all wonderful things... and occasionally they even turn out. How many years have the talking heads been saying this is the time for International? I only write that as an example of prognostications that have not materialized.

I think I'll do something you will appreciate..... if three years from now inflation is > 2.6% I'll dump my Rolex for a Calatrava.. if not, it stays on my wish list.
I'm not sure where you're going with this, TBH.

If, 5 years from now, CPI-U inflation is <2.6%, nominal bonds will outperform TIPS.

If, 5 years from now, CPI-U inflation is >2.6%, TIPS will outperform nominal bonds.

All of this is baked into the current prices.
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Re: Is the potential upside in munis worth the downside?

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watchnerd wrote: Wed May 05, 2021 4:00 pm
midareff wrote: Wed May 05, 2021 3:55 pm

I understand how they are voting with their wallets... just like tech buyers voted in 1997/98, and just like market buyers voted in 2007/8. Because someone, or a group of someones, or a whole herd of them vote with their wallet it doesn't mean the desired or expected ending happens. Projections and prognostications are all wonderful things... and occasionally they even turn out. How many years have the talking heads been saying this is the time for International? I only write that as an example of prognostications that have not materialized.

I think I'll do something you will appreciate..... if three years from now inflation is > 2.6% I'll dump my Rolex for a Calatrava.. if not, it stays on my wish list.
I'm not sure where you're going with this, TBH.

If, 5 years from now, CPI-U inflation is <2.6%, nominal bonds will outperform TIPS.

If, 5 years from now, CPI-U inflation is >2.6%, TIPS will outperform nominal bonds.

All of this is baked into the current prices.
Ahhh.. the great unknown and Efficient Market thrown in as well. It's all baked in as long as group think and reality collide. If not, then it isn't so baked in.
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Wed May 05, 2021 4:04 pm Ahhh.. the great unknown and Efficient Market thrown in as well. It's all baked in as long as group think and reality collide. If not, then it isn't so baked in.
I'm not clear on what reality collision you're referring to being at play here.

It's a simple over / under bet.

CPI-U inflation either comes in above or below the market's guess at the future.

If you think the market is guessing too low, you should buy TIPS. You'll outperform nominals.
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Re: Is the potential upside in munis worth the downside?

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watchnerd wrote: Wed May 05, 2021 4:10 pm
midareff wrote: Wed May 05, 2021 4:04 pm Ahhh.. the great unknown and Efficient Market thrown in as well. It's all baked in as long as group think and reality collide. If not, then it isn't so baked in.
I'm not clear on what reality collision you're referring to being at play here.

It's a simple over / under bet.

CPI-U inflation either comes in above or below the market's guess at the future.

If you think the market is guessing too low, you should buy TIPS. You'll outperform nominals.
Yes, many things can be boiled down to a simple over under bet. As long as all known variables are accounted for. Unfortunately life doesn't always work that way and planning for the unforeseeable is more difficult than simple over under bets. OTOH, I'm glad planning for the next 5 is so clear cut for you. Hope it works out the way you anticipate.
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Re: Is the potential upside in munis worth the downside?

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midareff wrote: Wed May 05, 2021 4:29 pm
Yes, many things can be boiled down to a simple over under bet. As long as all known variables are accounted for. Unfortunately life doesn't always work that way and planning for the unforeseeable is more difficult than simple over under bets. OTOH, I'm glad planning for the next 5 is so clear cut for you. Hope it works out the way you anticipate.
For the next 5 years, I've bought short TIPS because the downside potential of the market underestimating CPI-U inflation is potentially larger, with negative impacts to me, while the upside potential of the market overestimating inflation is relatively small and I'm willing to forego the small positive upside.

If inflation comes in unexpectedly high, I have some protection.

If it comes in lower than expected, I didn't need the insurance, anyway.
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