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A Scary Chart for Fixed-Income Investors

By Dan Ferris, editor, The 12% Letter
Monday, November 22, 2010

Fixed-income investors have fared well since the big market bottom in March 2009.
The big high-yield bond fund JNK is up 58% since then – a big return in a short time, especially for a junk bond fund. And the preferred stock fund PFF is up 180% since it bottomed out in March 2009. 
Investors have responded to high returns and the perceived safety of bonds by going crazy for them. According to Federal Reserve Flow of Funds data, investors are now pouring money into bond funds at rates of nearly $200 billion per year.
If that's you, you should look at what bonds have been doing lately…
Go online, find your favorite stock website, and get a six-month chart for BND, LQD, DSU, AGG, BIV, or any other big bond fund. They'll all show you the same thing. It looks something like this:
That's bad news for fixed-income investors. But there's one particular part of the bond market that's really falling apart.
Look up the symbol MUB. That's the national municipal bond exchange traded fund. Here's what you'll see…
Municipal bonds are crashing because the financial crisis has caused tax receipts around the country to drop… and because many states and cities have borrowed too much money.
These problems have been building for some time... According to credit-ratings agency Fitch, municipal bond ratings downgrades have outnumbered upgrades for seven consecutive quarters. That means the debt-repaying ability of states, cities, and towns across America has been falling for almost two years.
If you and I borrowed too much money, we'd sell assets and work to pay down our debts. State and federal governments just borrow more – making the problem even worse.
You can see this growth in government borrowing very clearly in reports from the Federal Reserve, called Flow of Funds. Below is the part of the Flow of Funds report that shows growth in debt for households, nonfinancial businesses, state and local governments, and the Federal government.
Take a look at the highlighted numbers... In 2009, households and businesses reduced debt at rates of around 2% per year. States grew debts by 4.9%, even though continued high unemployment rates caused by the financial crisis are virtually guaranteed to make it too hard to collect enough taxes to repay those debts. (The Federal government is even worse, increasing its debt by 22.7% last year, and at annualized rates as high as 24.4% per year in 2010.)
If you bought municipal bond funds – or almost any fixed-income investment – two years ago, congratulations. You've likely booked big capital gains in addition to outsized yields.
But like so many homeowners, commercial real estate owners, and financial institutions in the United States, many municipal bond issuers have borrowed more money than they're able to pay back. And the market looks like it's finally waking up to that fact.
It's time to take some of your fixed-income bets off the table.
Good investing,

Further Reading:

If you're still not convinced bonds are in a precarious bubble, go back and read Steve's August essay on bond funds...
As I write, 10-year government bonds pay 2.48% interest. Meanwhile, the average bond fund charges 0.61% in annual fees.
Think about that.
Right off the top, you're giving up 25% of the interest you'll earn to the bond fund manager. Why would you do that? Next, think about this: The BEST you can earn in interest in that bond fund is less than 2%. But the WORST case is really bad...
Learn the worst case here: Why Are You Buying a Stinkin' Bond Fund Now?

Market Notes

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CNH Global (CNH)... mining equipment
Halliburton (HAL)... oil & gas equipment
Dril-Quip (DRQ)... drilling equipment
FMC Technologies (FTI)... drilling equipment
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Magellan Midstream Partners (MMP)... pipelines
El Paso (EP)... pipelines
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Honda Motor (HMC)... Japanese cars
Tesla Motors (TSLA)... electric cars
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Simcere Pharmaceutical (SCR)... China health care
Biogen (BIIB)... biotech
Mattel (MAT)... toys

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Pulte Group (PHM)... "McMansions"

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