Three Hundred U.S. Municipal Bond Issuers Downgraded

Three Hundred U.S. Municipal Bond Issuers DowngradedI’ve been writing in Profit Confidential about the spree of bankruptcies in cities across the U.S. While the majority of them are in California, cities across America have been getting their credit ratings slashed.

In the second quarter of this year, Moody’s downgraded some 300 U.S. municipal bond issuers. This many downgrades of municipal bonds in a 90-day period represent the greatest number of downgrades in municipal bonds this decade. Some highlights: Moody’s downgraded $6.9 billion in municipal bonds associated with Detroit, Michigan, and cut the credit rating for Stockton, California. Stockton subsequently filed for bankruptcy on June 28. (Source: Financial Times, August 9, 2012.)

U.S. municipalities are facing declining property taxes, rising unemployment and large debt loads. Property tax collection, which is considered a main source of revenue for towns and cities declined again in the first quarter of 2012. After adjusting for inflation, property tax collections by U.S. municipalities have dropped for the past six quarters. (Source: Wall Street Journal, August 13, 2012.)

Keep in mind, dear reader, the majority of the municipal bonds that are issued do not carry any insurance to protect the buyer!

Three hundred municipal bond issuers getting their credit ratings slashed sounds alarming, but the picture gets worse. On August 15, economists at the New York Federal Reserve published a startling report on municipal bonds—a real eye opener.

Currently, there is $3.7 trillion worth of municipal bonds in the credit market. (Source: New York Federal Reserve, August 15, 2012). Municipal bonds are popular with individual investors, because they come with tax benefits…something U.S. Treasuries (in this low yield environment) do not provide.

Individual investors are the biggest owners of municipal bonds ($1.9 trillion). Mutual funds are the second biggest owners of municipal bonds ($930 billion), and insurance companies ($466 billion) are third.

Here’s the eye opener: from 1986 to 2011, Standard & Poor’s gave “default” credit ratings to 47 municipal bonds. Similarly, Moody’s gave default credit ratings to 71 municipal bonds from 1970-2011. But the data collected by the Federal Reserve indicates there may have been 2,366 defaults from 1986 to 2011!

Since the credit rating agencies such as Standard and Poor’s and Moody’s do not rate all the municipal bonds, the situation could be even direr. As a matter of fact, there were 36 times more defaults of municipal bonds reported by Federal Reserve than those reported by the credit rating agencies.

The financial issues faced by municipalities can lead to greater problems for the U.S. as a country. When more municipalities default on their bonds, individual investors (who own the majority of municipal bonds) will be hurt the most. The total market for municipal bond is $3.7 trillion, but Standard & Poor’s tracks only $1.3 trillion worth of municipal bonds. (Source: Washington Post, August 15, 2012.) This is nothing but alarming, and caution is warranted.

If municipal bonds are considered safe, why don’t investors have enough information as to what is going on in this $3.7-trillion market? If you own municipal bonds, make sure they are rated by a major credit rating service and beware of what the bonds are rated. Individual investors get excited when their income has preferred tax treatment—but the risk might not be worth it with many municipal bonds these days.

Michael’s Personal Notes:

I have been writing about the troubled eurozone economies and have questioned their ability to help stop their respective nations from crumbling.

There is growing evidence now of a widespread economic slowdown in the eurozone, something we started predicting in Profit Confidential in January of this year. I see the economic picture in Europe getting deeper and darker.

We all know that Greece’s economy has been in recession for sometime and shows no signs of economic growth. In addition, Spain, Italy and Portugal’s economies are in recession, so no economic growth there either.

On August 14, Eurostat data showed that the eurozone economy contracted by 0.2% in the second quarter of this year. The economic slowdown in Spain, Italy and Portugal was -0.4%, -0.7%, and -1.2%, respectively. The data also showed that Germany’s economy grew only by 0.3% in the second quarter. Austria and the Netherlands grew by only 0.2% each. The economy of Finland, which has an AAA credit rating, contracted by 1.0%.

Some suggest Germany is a strong country and should be able to avert the eurozone debt crisis by itself. Those people need to think again. Germany is facing troubles and witnessing its own economic slowdown. The labor market in Germany is bleak. Business confidence in Germany fell to a two-year low in July due to economic slowdowns and recessions in the neighboring countries. (Source: Bloomberg, July 31, 2012.)

Germany exports 40% of all its trade to eurozone countries. If the economies in the eurozone countries are suffering, the effect will trickle down to Germany. To give credence to my forecast, just look at Daimler AG. The world’s third largest maker of luxury vehicles reported a 13% declined in profits in the second quarter. Volkswagen reported that the impact of debt crises in eurozone is weighing on its product demand in the home region.

Here’s another interesting observation that should be noted. Before, it was the southern eurozone countries that were showing signs of economic slowdown or were in recession. Now there is evidence that the northern eurozone countries like Finland and the Netherlands are facing an economic slowdown as well.

The latest economic data confirm our beginning of the year forecast that the economic slowdown in the eurozone economy will lead them into another recession. This will not only make it difficult for the eurozone economies that are already in high debt levels, but also for nations like Germany.

The eurozone debt crisis is causing an economic slowdown in other parts of the worlds as well. Taiwan’s economy contracted in the second quarter unexpectedly. South Korea’s output fell in the second quarter and Japanese manufacturing fell to the lowest level since 2011. (Source: Bloomberg, July 31, 2012.)

As I have been writing, China, the eurozone’s biggest trading partner, is seeing its own economic slowdown. (See: “Chinese Economy Shows Signs of Severe Slowdown.”) This is very worrisome, as China plays a huge role in the global economy and any economic slowdown in the Chinese economy will have an immediate effect on the U.S. economy.

The current estimated growth in gross domestic product (GDP) for the U.S is 2.2% for 2012. At this point, it is very unlikely that U.S. GDP will grow at that rate. The effect of the economic slowdown in China is already being felt here in the U.S. More and more American corporations are providing negative outlooks and profit growth is falling rapidly.

The issues at hand, such as high unemployment, prove that economic growth is stagnant and also illustrate that the contracting global economy is creating a negative spillover effect on the U.S. If there are signs of economic growth, I can’t see them.

Where the Market Stands; Where it’s Headed:

The Dow Jones Industrial Average tried yesterday to break to a new post-credit-crisis high, but failed. Maybe it’s the slowing world economy. Maybe investors are finally cluing in that the recent stock market rally has been accompanied by very light volume (usually an indicator a rally will not be sustained). Or maybe the technicals of the stock market are deteriorating (see: “Beware: ‘Triple Top Reverse Pattern’ Almost Complete”).

For three years now, I have been writing that all we have witnessing since March of 2009 is a bear market rally (often referred to a “sucker’s rally” or a “bounce”) within the confines of a secular bear market. That conviction remains unchanged.

What He Said:

“There is no mixed signal about this: Foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously consider unloading their stocks of consumer-products companies that produce nonessential goods.” Michael Lombardi in Profit Confidential, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.