Munis

Over the past few months, munis have a hit hard, very hard. Even after the mild recovery since the end of June, index funds such as MUB (duration 7.17 yrs, distribution yield 2.97%) are down in excess of 7% YTD. High-yield munis, HYMB (duration 12.02 yrs, distribution yield 5.89%), are taking it even worse with a YTD drawdown of almost 12%. In a perfect storm of rising yields, illiquidity, high redemptions, and a default from Detroit to boot, munis are facing considerable challenges. HYMB, especially, is exhibiting considerable discount to NAV at the 3-5% level. Unfortunately, as others have noted, for highly illiquid assets such as muni bonds, the market price might actually be more accurate than the NAV. That said, even with the Detroit bankruptcy, which has been thrown back into court, the credit impact on HYMB should be muted as Detroit only comprises 1.33% of NAV and even all of Michigan only 3.53%. There is, however, the risk of other municipalities defaulting, but that risk has been there for a while. Note that muni bonds typically have high recovery rates (as high as 68%). The remaining headwinds of rising rates and redemptions will likely be challenging enough for the muni market. As the economy recovers and state coffers get replenished, the credit spread ought to tighten, but whether enough to counter the effect of rising rates is another question.

QE3 Fixed Income Aftermath

So what happens to fixed income after QE3? I thought it would be interesting to look at the max drawdowns versus the current 30-day SEC yields for a select cross-section of the fixed income ETF space for the past 52-weeks. All yields are quite compressed as is expected. Yields are so compressed that only MBB (US agency-based mortgage bonds) has a 30-day SEC yield exceeding the max drawdown. TIPs have negative yield as was true for quite a while now. It seems the contagion of return-free risk has spread to most of the fixed income ETF universe at this point.

Market Manipulation, Part 1

If the investment advice and forums are any indication, a lot of people consider the markets rigged and manipulated. But what is a good working definition of manipulation? There is price manipulation. That entails the defining what an "artificial" price is. Price manipulation is probably one of those things with a long, long history. One of the most famous cases is that of the Hunt brothers' attempted cornering of the silver market in the late 1970s and early 1980s. Market bubbles may also contribute to "artificial" prices, but bubbles are more of a natural psychological reaction of market participants, not some insidious conspiracy. This difficulty works both ways. Government and industry regulatory organizations cannot be too specific about what signals of fraudulent market activity they are scanning for lest the perpetrators simply work around those signals to escape detection. Besides straight price manipulation, regulatory agencies also consider order flow and spread manipulation.

Johan and Cumming did a study on Market Surveillance regimes around the world in a 2008 paper Global Market Surveillance.

Rosa Abrantes-Metz has written a number of papers on the subject including a 2007 paper Is the Market Being Fooled? An Error-Based Screen for Manipulation.

Forward Looking

Now that the holidays are over, what is going on in the markets? A couple of European debt auctions went fairly well last week. This does not change the overall long-term picture, but looks like nothing collapsed over the holidays. Moreover, the Iran-Strait of Hormuz situation could have spun out of control early on, but it did not (yet).

I was curious what news items were affecting the companies on my equity watch lists (both long and short). On the growth side of things, the basic materials and energy side lead the market (APA, EOG, ROSE, APC, HAL, NE, MOS, FCX). FCX is up ~6%. The rest are up more than 2% for the most part. HAL is suffering from some headline shock due to its spate with BP (BP is asking HAL to foot the cleanup bill plus lost profits), but the damage is mild since nothing is decided yet.

Vicious Cycle

The Fed didn't ride in with the cavalry today. Looking from their perspective, why would they? The domestic data from the past few weeks did not indicate catastrophe. Popular support for further easing is tenuous at best. The main risk is from the debt situation in Europe. The evanescent hope that fueled the past few weeks' action dissipated just as quickly. The Dollar and Treasuries skyrocketed from the lows of the day. In Europe, there is a vicious cycle going on. The large private holders of sovereigns (i.e., banks and funds) insist on being made whole, thus pressuring the very sovereigns they don't want to default. The European governments insist on more and more austerity, negating what little chance they had to have secular growth lift them out of the mess.

Share Buybacks, Part 3

Following my previous discussions of share buybacks here and here, let's look into the distribution of the share counts for the PKW (Share Buyback Achievers ETF) components. The components of the Share Buyback Achievers exhibit significant diversity in outstanding shares. For this study, I used the outstanding share information from Yahoo Finance which appears to be a rough undiluted number. The mean, median, and standard deviation of share count are 242M, 81M, and 430M respectively. The component with the minimum number of shares outstanding in this fund is homebuilder NVR with a mere 4.98M shares out. Mega-retailer WMT has the most with 3.44B shares.