Finally, an Attractive Asset Class Emerging?

The S&P500 crawled up another 1.7%  last week on declining volume.  The VIX (or fear) index fell to near one year lows, as many wise analysts are warning of complacency taking over the stock markets.  These crowd followers claim: “Why worry?  Just keep buying because the Federal Reserve wants stock prices to go up?  It’s can’t lose bet.” 

We’ll see about that.  Similar claims were common in late 1999 and early 2007.  Things didn’t–clearly–turn out as the cheerleaders had promised.

Economically, the week were mostly weaker than expected.  Wholesale trade disappointed.  Year-over-year changes in import and export prices show signs of growing inflation pressures.  Jumps in CPI and PPI both pointed to the same conclusion.  Initial jobless claims soared right back to the mid-400,000 level associated with recessions; the non-seasonally adjusted claims figure went through the roof, spiking to 770,000, calling into question how the headline number could be “adjusted” so dramatically.  Retail sales came in below expectations.  Industrial production was better than forecast; consumer sentiment and business inventories were lower.

Technically, the S&P is behaving just as a heavily Fed-manipulated market would be expected to behave.  The S&P has not closed below its 50 day moving average for a longer time than it has in decades.  It’s closed above its 10 day moving average longer than ever in its history.  This is not normal market behavior.  It is easily explained when one considers the billions of dollars that the Fed pumps into the capital markets on a monthly basis. 

So as almost all asset classes are being artificially inflated to higher and higher values, making the attractiveness of buying them grow dimmer and dimmer, it’s refreshing to see one asset class that’s heading in the opposite direction.

As boring as it may seem, the muni market has been full of fireworks lately.  After prices (for short and long maturities) peaked in late October 2010, they’re started a steady decline.  By last weak prices for many medium-term muni ETF’s have dropped over 10%. 

How bad is this in the muni world?  It’s catastrophic.  The drop in one of the largest ETF’s, MUB, has wiped out all the gains from the last year and a half. 

What’s causing the plunge?  A combination of factors: the retirement of the Build America Bond program, the sell-off in US Treasuries, and perhaps most importantly, the growing fears that state and municipal fiscal health is bad and will get much worse in the upcoming year.

But setting aside the exact reasons, what’s making muni’s stand out is that their prices are FALLING when pretty much every other investment asset class is RISING, courtesy of the Fed’s money printing.

Why is this important?

First, the lower muni prices fall, the more attractive they will become to a long-term investors, you know the kind that own their securities for months and years, not milliseconds.  Is it time to jump in and buy now?  No, not yet.  The safest time to buy–technically–will be when prices stop falling, and that hasn’t happened yet.  So let them keep dropping; the more they fall, the greater the margin of safety when purchases are finally made.

Second, the muni market is collapsing DESPITE the massive money printing of the Fed.  So if the muni market can still crash, then why is it that other investment asset classes can’t crash?  

That’s right, there is no strong reason.  So while the muni market may soon become a terrific buying opportunity for value-oriented investors, it should also serve as a reminder that NO asset class can–or will–rise forever without a severe correction.

Here’s looking at you Mr. (Stock) Market.

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