Bonds

Roughly 20% of the nearly 50,000 issuers of U.S. municipal debt do not supply timely disclosures after their bonds have been issued (source: WSJ, May 2013). It appears Harrisburg, Pa is one of those municipalities, agreeing to settle SEC charges. The SEC faulted Harrisburg for making misleading financial statements from 2009 to 2011. The SEC brought a similar case against New Jersey in August 2010.

Yields on 10-year U.S. Treasury Bonds have been trending downward for the past 30 years (1983-2012). In 1983, $100,000 invested in 10-year Treasuries generated $11,100 of annual income. In 1997, $100,000 generated $6,350 in income; in 2012, $100,000 invested in 10-year Treasuries paid out just $1,800 in income each year.

On May 13, 1981, the three-month T-bill rate was 17.01%, when the Dow was under 1,000. During March 2013, three-month rates were 0.12%. When rates do begin to rise, whenever that may be, the over $30 trillion U.S. bond market may be in for a wild ride.

According to Moody’s, the cumulative default rate for high-yield municipal bonds from 1970 through 2011 was 7.94%; this translates into an average annual default rate of 0.19% (7.94/42 years). Over the same period, investment-grade municipal bonds had a cumulative default rate of 0.08% (or 0.002 per year).

Treasury inflation-protected securities (TIPS) are issued by the U.S. Treasury and are designed to keep pace with CPI increases. The first TIPS were issued in 1997. TIPS comprise two parts: a real return and a CPI adjustment every six months. The “moving part” is the CPI change. The “real return” is a locked-in rate that stays the same until the maturity date. Investors earn a fixed rate of interest on an ever-increasing amount of principal.

The long-term default rate for GO bonds, which represents 40% of the municipal bond marketplace, is just 0.01%. According to Municipal Market Advisors, municipal bond segments with the highest default rates are: [1] community development districts (17% of issues), [2] assisted living (5% of issues), [3] independent living (4% of issues), [4] nursing home (3% of issues), and [5] telecom (3% of issues).

From 2008 to 2012, investment-grade and high-yield corporate bond funds doubled in size, to $1.2 trillion and ~ $250 billion, respectively. The U.S. junk bond market is estimated to have an overall value of $1 trillion. Over the past 15 years, the “spread” between high-yield corporates and Treasurys was six percentage points. As of February 2012, the high-yield bond index was yielding 7.3%, far below its 15-year average of 10%.