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Why Billions in Bond Portfolios May Soon Evaporate
Muni and junk bond investors rush in when it may be the worst time

By Bob Stokes
Thu, 15 Nov 2012 18:00:00 ET
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Money has recently poured into municipal and junk bond markets. 

In the case of muni-bond investors, many fear the tax hikes that will be triggered if lawmakers go off the "fiscal cliff."
 
Investors are barreling into municipal bonds, driving yields to record lows and hoping for a safe hiding place at a time when taxes are almost certain to rise.
 
From Nov. 7 to 12, about $500 million of new money flowed into muni bond funds.
 
CNBC, Nov. 14
 
Even so, muni-investors are apparently ignoring the precarious financial state of municipalities.
 
Conquer the Crash warned that muni bond tax exemptions would “ultimately trap investors into a risky position,” and the Elliott Wave Financial Forecast has continually stated that defaults will rise as cushy municipal pensions and health benefits garner a bigger share of a decreasing tax base.
 
The Elliott Wave Financial Forecast, May 2012
 
Consider that municipal bond defaults have happened more times than many investors suspect.
 
Municipal bonds, widely seen as one of the safest investments, actually default more often than most people realize. ... For example, Moody’s Investors Service has reported that from 1970 to 2011, there were only 71 municipal bond defaults. But the Fed report counted 2,521 defaults in that time.
 
New York Times, Aug. 16
 
Junk bond investors, on the other hand, want high yields.
 
Through Sept. 26, the Wall Street Journal reported a $33.67-billion net inflow into junk bond mutual funds and ETFs in 2012, which sent prices to 5-year highs.
 
A chart from the September Financial Forecast and the accompanying commentary offer more insight.
 
 
 
Despite a steady deterioration in the economy ... investors' willingness to finance the debt of the weakest U.S. companies is greater than ever. The second line on the chart—the spread between the yield on 10-year U.S. Treasuries and junk bonds—provides a subtle yet dramatic clue to the disastrous consequences of this epic "yield grab." The spread failed to follow yields to a new low (a high on the chart, which is inverted). Note that the same behavior occurred prior to the October 2007 all-time high, when the spread started widening in June, four months ahead of the Dow’s peak.
 
The Financial Forecast, September 2012
 
And now, the November Financial Forecast provides more insights into the junk bond craze with two new charts. One shows the Elliott wave structure of the Bank of America Merrill Lynch High Yield Master II Index.
 
 

  

 

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