MUNI: A Great Opportunity

If you are an income investor, you must know the Municipal Bonds, so-called Muni. As you may know, city governments in the US have only one revenue source, i.e. the property tax. However, they have tons of obligations to maintain the municipal operations such as social safety, school, road maintenance, and public projects etc. To fund various costly infrastructure projects, municipal governments issue various bonds. To encourage investors to buy Munis, the federal government exempts the tax for the interest income from Muni bonds. Historically, Munis are a very safe investment and a quite popular option for those who want to have stable income. It is reported that the default rate for Munis since the Great Depression has been less than 0.1%.

Due to the obvious reasons, the municipalities across the country are now facing a huge financial crisis, especially in a few states such as IL, CA and NJ, where the whole states are basically bankrupted. It was reported that Camden in NJ, which is the 2nd most dangerous town in US, has substantially cut down the police budget due to the budget crisis. That's why the famous market analyst, Meredith Whitney, claimed in CNBC a couple of weeks ago that 50 to 100 municipalities would go belly up this year and accordingly the Munis of such  states and cities would be on default totaling hundreds of billions of dollars, meaning they would not be able to pay the interests to the Muni bond holders. With this kind of news out there, individual Muni investors ( Dumb Money) are really scared and running away from Munis as fast as they can. So in the past few weeks, we have seen a hair cut of Munis prices by around 20%. This is a huge drop for Munis since they are typically very stable and don't fluctuate very much during a short period of time. For savvy investors (Smart Money), this actually creates a very great opportunity for investing in Munis, which may not come very often. 

While I do appreciate the very dire situation for municipalities, let's face it. The American people will still need to continue with their life, for which an orderly operations of municipalities will need to continue one way or the other. It is certainly possible that many cities may go default, but the majority should still be able to go through it, although may not as comfortably as in the past. In the past 100 years, the US has also gone through many tough periods, some of which were at the similar scale as this one, but the default rate for Munis has been extremely low. If the Obama government would bail out the car and real estate industries, do you really think it will simply let many municipalities go kaput, which may cause a huge social instability? I highly doubt it. That's why the Bond King, Bill Gross, openly challenged Whitney by saying that he did not believe what she said and would consider this as a great opportunity to buy Munis. He actually did so with his own money. Similarly, another top Muni bond fund manager, Lyle Fitterer,  is also very bullish on Munis.

I think you should follow the Smart Money and it is worthwhile to consider to buy Muni funds instead of individual Muni bonds. I like  Nuveen Insured Municipal Opportunity Fund (NIO) very much, which generally invests in relatively sound Munis. It recently dropped from over $15 to $12 but it has recovered a bit at around $13. At the current price, its yield (interests you get) is about 7%. Since it is tax free at the federal level, you are actually getting at about 9% if you are at the top margin tax bracket. Of course nothing is risk free. To protect yourself, you should always use a stop loss to protect your capital. I suggest you use a 10% trailing stop loss to exit this investment if its share price falls below 10% of the highest price after you have bought it.