Muni Meltdown

by Addison Wiggin

• Dec. 31 doom? The double whammy about to hit income investors

• Euro “at risk of another crash” as Ireland jawboning drags on

• Labor Department looks around, sees no inflation… Your Thanksgiving turkey begs to differ

• Surveying market crashes back to 1720… and a disturbing recent trend

Yesterday was a “risk off” day. The dollar index floated above 79. Stocks and commodities got hammered.

Still, this morning, since our mind tends to wander away from the herd, we were struck by another sell-off that began earlier this month, and accelerated big-time on Monday…

That’s just one example among many municipal bond funds that were humbled in a biblical way. They recovered a bit yesterday, but not enough to regain their former hubris.

In fact, Monday was the worst day for municipal bonds since the Panic of ’08, the yield on 10-year AAA debt blowing out from 2.75% to 2.93%.

That prompted several issuers to hold off on new financing plans. For instance…

• Orange County, Calif., postponed the sale of $160 million in Build America Bonds (about which more below). “The bond market has been pretty volatile and flooded with new issues,” says county controller Mike White

• Cleveland’s public hospital system postponed the sale of $100 million in bonds intended to refinance existing higher-interest debt.

“Yields rose in such a way that our refunding didn’t make sense anymore,” says president Mark Moran of MetroHealth System in Cleveland. Heh, if he thinks yields are high now, and it doesn’t “make sense” to enter the credit markets, he’s in for a rude shock.

The Great Recession cratered revenue for states and municipalities all across the nation. Desperate to make ends meet while still maintaining existing levels of services, they did the logical thing: They cried to Washington, D.C.

Of course, as we’ve been observing in excruciating detail, Washington came through — big. Unfortunately, that milk and honey was flowing from a dry teat.

Thus, with morose trepidation, we forecast this morning that the municipal bond market is facing a double whammy day of reckoning, on the two following dates:

• Dec. 31, 2010: Funding for Build America Bonds runs out. These bonds were part of the “stimulus” bill passed early 2009, subsidizing municipalities’ costs for public works projects to the tune of $150 billion.

• June 30, 2011: Still more federal aid expires on this date — some of it authorized by the “stimulus” bill, more under the “jobs” bill passed last summer, totaling another $150 billion to date. Without this money, states would have already slashed a host of programs, including unemployment benefits and Medicaid.

Days of reckoning are never “fun” per se. Least of all will these be for the savers and retirees who’ve purchased municipal bonds because they’ve been deemed a safe source of tax-free retirement income for, well, ever.

The iceberg looming beneath the surface: A host of corporate and state pension plans rely on munis too.

With these looming deadlines in mind, our Lifetime Income Report editor Jim Nelson has just updated his presentation on the “Plan B Pension” — a package of ideas that deliver reliable income without the default risk that will stalk the municipal bond market for months, if not years, to come. Check it out right here.

The venue for the ongoing drama that is Ireland and the euro is shifting today from Brussels — where a bevy of meetings accomplished nothing — to Dublin.

A plague of bureaucrats from the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Commission (EC) is being visited upon the Irish capital. They will say, when they arrive, that they’re there to help.

Ireland’s finance minister insists his government needs no bailout… it’s Ireland’s banks that need help. The IMF and ECB beg to differ. Either way, $136 billion is the number on the table.

“The Irish government claims to have enough liquidity to last through mid-2011 without tapping the bond market,” says our Strategic Short Report analyst Dan Amoss, keeping an eye on the impending bailout’s likely global impact, “But this is a solvency issue, not a liquidity issue. This government has effectively hit the debt wall.

“Ireland will eventually need to restructure its debts (including haircuts for bondholders) to avoid paying a politically unacceptable share of its GDP to bondholders.

“Greece and Portugal will likely restructure, as well. In my view, over the next six-12 months, the euro is at risk of another crash against the U.S. dollar, as Germany's export prowess is simply not enough to both support its own economy and continue to bail out its neighbors.”

Stocks are drifting today after yesterday’s washout. So is gold, at $1,338. Traders can’t even rouse themselves to react to news that housing starts slid 11.7% last month, to an 18-month low. Most of that drop came in the condo/apartment sector.

Options Hotline readers had already built in protection against yesterday’s broad decline.

"Near term,” editor Steve Sarnoff advised readers on Sunday, “I’m watching to see if some surprising strength in the U.S. dollar puts a bit of pressure on stocks and commodities."

He recommended put options on an Internet darling. As the market sold off, this play jumped 20% in less than two days. (Update: As of this morning, it’s up 28%.) So far this year, 13 of Steve’s recommendations have doubled or better… and three of them were good for more than 300% gains. Options Hotline is still available at an absolute steal… but only through this weekend.

A frozen turkey sold wholesale hit a record $1.09 a pound last Thursday, according to the commodities research firm Urner Barry. That’s up 28% from a year earlier.

Blame it on rising feed costs — we’ve chronicled rising grain prices in this space all summer and fall. Corn makes up 70% of turkey feed, and that’s jumped 47% over the last year.

Worse, turkey production is down 1.3% this year, according to the Department of Agriculture — putting an even bigger squeeze on your bird.

We suspect Wal-Mart won’t be repeating its stunt last year, when it sold turkeys at retail for 40 cents a pound.

Yet despite the above, rather timely, holiday exhibit, the Bureau of Labor Statistics (BLS) has conjured a figure for the consumer price index (CPI) that confirms everything the Federal Reserve is saying to justify QE2.

We’re told the cost of living rose 0.2% in October. The “core” rate for those of us who don’t consume food or use energy was flat as a crepe.

(Longtime readers, please indulge newer readers this brief explanation: The Bureau of Labor Statistics performs amazing sleight-of-hand feats to make it look as if prices aren’t rising. Are you buying less steak and more hamburger? Well, then, your cost of beef isn’t really rising. Economists in the employ of the government and those who go along with the charade call it “the substitution effect.” And there’s much more where that comes from.)

Still, these are the numbers the market will react to: Year over year, CPI is up 1.2% and the core rate is up 0.6% — the core being far below the Fed’s sweet spot of about 2%.

The fact you likely paid more for groceries last month — or health care, tuition, gasoline, clothes, McDonald’s french fries or a myriad of sundries from Wal-Mart — is irrelevant both to the Labor Department and the Fed.

Besides, if the Fed can’t create “inflation” as they define it in the United States, they’re doing a bang-up job of it elsewhere.

As they’ve driven interest rates to lifetime lows here in the homeland, investors are seeking returns in emerging markets. And just look at what all that “hot money” has accomplished.

No wonder India just raised interest rates. China’s looking to do the same.

China grew its holdings of U.S. Treasuries in September by 1.7%. The Middle Kingdom now possesses $884 billion in sovereign U.S. debt. Japan’s holdings grew at an even faster clip, to $865 billion.

For the moment, America’s two largest foreign creditors remain unconcerned about Treasury’s issuance of debt… or, for that matter, the Fed’s increasing purchases of it.

“What is meant by references to QE2?” a reader inquires. “I am a very recent subscriber and have no idea whether that refers to the ship or is some esoteric stock market term. Please enlighten me.”

The 5: Sure. Quantitative easing is the Federal Reserve’s preferred term for when it pumps new money into the banking system. Its second round of this (hence, “QE2”) involves buying $600 billion in U.S. Treasury debt over the next eight months.

For your enjoyment, we continue to recommend this very basic explanation, as do your fellow readers.

“The QE explanation was the absolute ultimate in drawing an analogy — and slapping those in the political field creating that great debacle — one of the funniest and well-expressed videos I have ever seen.

“I have forwarded it on to many in the financial field and to many other friends who are investors that also thought it was awesome. This report is quick and awesome.”

“Your ballyhooed ‘build-out’ of nuclear power is not supported by Wall Street,” a reader gripes, “which hasn't been keen on investing in nukes for 20-30 years. It all rests on safety nets from the Feds.

“I rather doubt that the new House, with their knives sharpening to cut the budget, is going to vote for any more of those, no matter what the Senate does. For the record, I am a lifelong environmentalist who is pro-nuclear power except for one glaring problem: rapidly rising costs.”

The 5: Well, at least the Chinese seem to be getting it. They’re currently building 23 nuclear power plants with more on the way. Russia, South Korea and Pakistan are also coming online. Our contention is uranium will be a good investment over the years to come regardless of what Wall Street or Washington make of it. You’re, of course, free to place your bets as you wish.

“As a gringo resident in Costa Rica for about five years,” writes another, “I find your Wag the Dog comment a bit inappropriate. [Nicaragua’s president] Ortega has put armed troops on Costa Rican soil in an unwarranted invasion. Unlike Canada and Alan Alda, Ortega has real designs — his troops have already completed the initial ditch to create a new mouth for the San Juan River.

“A new mouth would significantly benefit the Nicaraguan economy as a major component for a second Panama Canal and, arguably, chop off a small chunk of Costa Rica for Nicaragua.

“You are foolish or ignorant of the situation if you don’t think that Ortega has a serious objective in mind. The risk is low since pacifistic Costa Rica has no army and must rely on support from the nutless wonders at the OAS. Giving the Nicaraguans a cause celebre is only a side effect, not the real objective.

“The 5 is almost always spot-on, but you sure missed it this time! Keep up the good work. If you didn’t make an occasional boo-boo, we wouldn’t appreciate you as much the rest of the time!

“Having been to Rancho Santana (as well as various other parts of Nicaragua), it is indeed as beautiful as you say. And most of the Nicos I have met are wonderful people, even if they are only as adept at electing leaders as voters in the USA.”

The 5: Our guys on the scene say, ironically, part of Nicaragua’s justification for moving troops into that part of Costa Rica stem from a faulty map published by Google maps. Go figure, huh? Geopolitics in the age of information… next Daniel Ortega and Laura Chinchilla will be “unfriending” each other on Facebook.

Ostensibly, the strategic reason for dredging the mouth of the San Juan is simple: It will open the door to a canal stemming from the Atlantic side at least as far as the giant Lake Nicaragua — perhaps even further to the Pacific — which would help Ortega with trade relationships he’s trying to forge with Russia, China and Iran. If you can put aside your distaste for those regimes, the boon for Nicaragua’s economy could be immense. (Provided, of course, they don’t completely boondoggle the project for years to come…)

Fact is, you’re right: We don’t know. We’re as quick to admit that as we are to admit we don’t know what Wal-Mart is putting in their steaks (which are awful) or what goes on between the ears of “the Bernanke.”

The situation does bear watching… if only, in the end, for entertainment value. We’ll be doing so from close range during our (sold-out) Chill 3.0, Dec. 17-21, 2010. As always, we’ll do our best to keep you up-to-date.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S.: Next Monday at noon, we’re taking the wraps off an experiment that one of our up-and-coming analysts conducted this year. To give you a sense of what the experiment’s has been all about… we turn the floor over to him:

There's an interesting list of stock market crashes on Wikipedia, from the Mississippi Bubble 290 years ago right up to the Flash Crash of earlier this year.

The full list here. Take a quick look now and then come back and read the rest of this short article to find out what it all means. I'll wait right here for you. I don't mind…

What you can see is from 1720-1929, there were 17 notable market crashes. That's a rate of one crash every 12.3 years.

BUT from after the Great Depression right up until today, there have been 19 notable market crashes. That's a rate of one crash every 3.9 years!

This is a very worrying statistic, my friend.

If you believe history is the ultimate guide to the future, as I do, then history is screaming at investors to run for the hills, because the stock market is going to get more and more unpredictable.

In fact, even as we speak, the Dow looks like it's sucking for air again. Could another big crash be imminent? Many respected analysts think so.

Whether it happens or not, the truth is the market has changed dramatically over the last 290 years. That's plain to see, experiencing very rapid change since the Great Depression.

But then…

Does that mean you should listen to the market and get out?

NO! (Tomorrow, I'll make the case that there's more opportunity than ever.)

Does that mean you must change how you invest as the market changes?

YES! (But it's easier than you think; I’ll explain that tomorrow, too.)

If so, does that make Warren "buy and hold" Buffett a fool?

I'll reveal all tomorrow, in another short piece called "Kings of the New Market (and How to Steal Their Secrets)."

You'll find me in the same place, right here at the bottom of The 5 Min. Forecast.

I'll see you then.

Cheers,

Jonas Elmerraji

P.S.: On Monday, Nov. 22, I'm sending you a very important email about all of this. Keep your eye out for it, because it's essential you read it immediately. Stay tuned for more details in tomorrow's "Overtime" briefing.