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The Signposts of Change
By William Parmenter, editor
Ron Muhlenkamp, CFA, spoke on the topic of “The Signposts of Change: Economics, Rules and Markets,” at the May 15 AAII Los Angeles chapter meeting at the SkirballCenter.
Muhlenkamp is the founder and president of Muhlenkamp and Company, established in 1977 to manage private accounts. He added a no-load mutual fund in 1988. His quarterly newsletter is Muhlenkamp Memorandum.
He has a B.S. degree from MIT in engineering, an MBA from Harvard and a CFA designation.
In his talk, Muhlenkamp looked at the last two years, the recession, the bail outs of the big financial institutions, and took a look at what is going on today, referencing various indices he monitors.
Muhlenkamp said every time he mentions that the recession is probably over, peoplelaugh at him. That impels him to mention that there are at least three different kinds of recession.
The first definition of a recession is that of the economists, which is two quarters of GDP decline.
The second definition is that of the mass media, which does not think that a recession is over until everyone who lost a job has a new one, GDP is back above where it was, and unemployment is below where it was.
And third is the investor’s point of view about recessions. For the investor, the recession ended in March, 2009. (As an investor, if you wait for confirmation that the recession is over, you have probably missed most of the up move. So, to be a successful investor, do not let the media set your agenda.)
The aggregate numbers between the recession of 2008 and previous recessions look familiar: in GDP, employment, a Fed squeeze with an inverted yield curve and a weak dollar.
The minuses of the 2008 recession were: the crunch in financials and the credit markets, and the rise in the price of energy and food prices. Due to the crises in financial institutions and in real estate, consumer confidence may stay low for some time to come.
The pluses of the 2008 recession were: that the U.S. is a service economy, corporate balance sheets are in great shape, and the international growth of India and China helps the U.S. economy. International liquidity coming to the aid of financial institutions was another plus.
The weak dollar was a plus for the producers selling products abroad, and a minus for the American consumer. It will take some time for the American consumer to rebuild his
balance sheet.
Table of ContentsSignposts of Change………Ron Muhlenkamp………..p.1
Municipal Bonds…………...John Larson………..…….p.3
Investor Education…………Dr. Don Gimpel...………p.5
Muhlenkamp believes the current recession is over. The trigger that started it was $4 a gallon gas.
Between 1945 and 2009 there have been 12 recessions. Recessions occur about 25 percent of the time, coming about five years apart.
Most of the recessions coincided with drops of 20 percent of more in the S&P 500 index. In the recession that ended in March, 2009 the S&P dropped 52 percent, the greatest of any post-war recession, including the 49 percent drop in 2001-2.
For years Muhlenkamp said recessions serve a useful purpose. Now he thinks that recessions are necessary. They are needed to rid excesses in the economy. And, they are self-correcting. In a recession, people tend to spend a little less and save a little more, and the pattern tends to heal itself.
What was the impact of the recession on the consumer?
In the fourth quarter of 2008 the consumer went from spending 100 percent of his income to spending 95 percent. In one quarter the savings rate went from zero to 5 percent.
Charts of crude oil, natural gas, corn, soybeans, wheat and rice showed big price run ups to a peak in 2008, and then collapsing back to where they were around 2007. The rates on 30-year mortgages ran up to a peak in 2008 and then have dropped off to around 5 percent.
The housing affordability index is the best it has been in 40 years. It is a very good time to buy a house if you intend to live in it.
People today, who did not lose their job, are in a better position from a cash flow position than before the recession. Food, clothing and housing are actually cheaper.
Muhlenkamp next considered the impact of the recession on financial institutions.
Bank deposits have continued to grow. Small regional banks are in good shape, with equity as high as 18 percent of assets. They almost have too much equity. It was the big banks that got in trouble this time.
This recession differed from normal cyclical recessions due to the credit crisis and the resulting bailouts.
Regarding outstanding commercial paper, there was a small drop in non-financial commercial paper (business to business), and a large drop in commercial paper (bank to bank).
After Lehman Brothers went broke in September, 2008, much of the financial industry locked up, precipitating a credit crisis. Illustrating the credit crisis, in late 2008 the three-month Treasury Bill and the three-month LIBOR moved in opposite directions.
Since then the LIBOR has come back down to the lowest level in a long time. By now, the factors that seized up the financial
industry, for the most part, have worked their way through the economy.
The credit seizure problem could reoccur
due to the problems of the southern European banks, particularly in Greece and Spain.
Many of the causes of the credit seize up
Los AngelesCountyMeeting ScheduleWestside Computer Group – Don Gimpel, 310/276-9875 Steve Hunter on UltraFS version 11, Garden Room at Veterans of Foreign Wars Memorial Bldg. Culver Blvd. & Overland Avenue, Culver City, from9 a.m. to noon on Saturday, June 5.
Pasadena Group– Ivan Wong. Topic TBA The groupmeets at Lamanda Library, 140 S. Altadena Drive, Pasadena. On the third Tues. of the month, except for August and December. Topic and speaker to be announced.
Mutual Fund Group – Gunter Hagen 310/457-7404, . To meet at 10:30 a.m. Saturday, Date and Topic TBA, at Fairview Library, 2101 Ocean Park Blvd., Santa Monica. The meeting is free to the public
Stock Selection Group—Norm Langhout IBD’s ‘Can Slim’ method of investing 310/391-6430, . Fourth Wednesday of the month at 7 p.m. Fairview Library, 2101 Ocean Park Blvd., Santa Monica. Topic TBA
Options Group—Robert . Meets monthly at 9a.m. at Community Room A in the Westside Pavilion, 10800 Pico Blvd., Los Angeles, CA90064 Topic TBA.
Desert (Palm Springs area)—Patricia Gammino; Time date, topic and place TBA. .
Los AngelesChapter SkirballCenter at 9 a.m, Sat. June 19. David.T. Fractor & G. Michael. Phillips on A New Approach to Measuring and Managing Investment Risk; and Steve Hornstein, on I Have a Will, Why Do I Need a Trust?
in the U.S. have been resolved. The repercussions, however, will be lingering for years to come. It is not possible to predict when the repercussions will be over, so Muhlenkamp will continue to monitor: consumer spending, business investment, velocity of money, Federal Reserve and Treasury activity, credit defaults, bank health, taxes and regulation.
The status today is marked by some differences compared to the past. These differences include:
1.Consumer confidence will remain subdued for a period of time.
2.Reduced consumer spending will link to slower growth. The annual GDP growth will fall from 3.5 percent to around 2 percent, because consumers are saving more and spending less.
3.Return on shareholder equity could fall from 13 percent on average to 11 percent, due to reduced orders for durable goods, reduced consumer spending and reduced capacity utilization.
4.Price earning ratios could be lower, due to the less attractive returns on investments in corporations.
Going forward, Muhlenkamp expects unemployment to be slow to come down. He also expects there to be a huge demand for financial advice.
In the question and answer session that followed his talk, Muhlenkamp pointed out that it is hard to figure out the future. Partly that is due to the November, 2010 elections, with possible changes to the rules that affect the economy and the investment outlook.
You may learn more about Muhlenkamp’s company, his ideas on the economy, recessions, his public lectures and slide shows, and his mutual fund and private accounts, at his website at
Income Investing: Municipal Bonds
By William Parmenter, editor
John Larson spoke on Income Investing: The Safety of Investing in Municipal Bonds at the May 15 Los Angeles Chapter AAII meeting at the SkirballCenter.
Larson is senior vice president, portfolio manager and head of wealth management at the First Private Bank and Trust in Santa Monica. He has a B.A. with honors in economics from UCLA and an MBA in finance and accounting from UCLA’s Anderson School of Management.
How safe are municipal bonds? Are they the place to be investing in the turbulent market of today?
An expert in fixed-income investing, Larson provided a densely detailed overview of various types of municipal bond investments, with an emphasis on their historical records of safety.
In size, the municipal bond market is $2.8 trillion, with 80,000 issuers and 1.5 million issues outstanding.
Among the many topics he addressed, Larson pointed out at least 10 different kinds of municipal bonds. Among them are: general obligation munis, revenue bonds (for essential purposes like garbage, and electricity), and tax-dedicated/backed bonds (these are highly predictable and not likely to default).
Others include: certificates of participation, pre-refunded, build America bonds, and territorial bonds. Then, too, there are insured bonds, zero coupon bonds and a variety of short term bonds (BANs, TANs, TRANs, RANs and VRDOs.
Larson pointed out various ways munis are priced by the market. That includes: par value (the face amount), the market value, current yield versus yield to maturity and new issue versus the secondary market.
In buying munis the buyer needs to beware (caveat emptor). There is no exchange for buying munis. There is no centralized trading, little regulation and the market is inefficient.
Since munis are sold on the open market there is room for abuse with too much mark up. The buyer can go to to see how much the mark up was. The investor can use the website to do credit and price research. A second website, can also be used for credit and price research.
The two key strategies for muni portfolios are passive (buy and hold) versus the active approach (managing for total return).
The most common approaches to portfolio structuring are: concentrated (all due in one year), the laddered, (the most common, with maturities staggered over several years), and the barbell (some with 2-3 year maturities, and some with 7-8 year maturities). The goal is to compensate for interest rate fluctuation.
There are various kinds of risks associated with buying munis. The risks include: interest rate risk, call risk, reinvestment risk, credit risk and default risk. There is very little default risk in munis, so investors very rarely lose their principal.
How safe are municipal bonds? Defaults are extremely rare, especially for investment grade bonds. Issuers are able to borrow at beneficial rates. The default rate for BBB munis is lower than that of AAA corporates.
State and local governments have a significant margin of safety between credit deterioration and default. The period is greater for states. Usually credit deterioration takes time.
State issuers have a number of resources and recourses. Among them are: the sovereign power to tax, they are monopoly providers of essential services (for example, electricity); the state cannot declare bankruptcy; 49 out of 50 states are required by law to balance their budget.
States can shift spending downward and cut services; states can restructure debt; and they have political influence (for instance California issued IOUs) and legal protections.
Local municipalities also have a variety of resources and recourses. Among them are: the sole power to levy property taxes; (72 percent of local revenue comes from the stable income stream of property tax);municipalities are the sole provider of essential services (for example, sewer, water and garbage collection).Municipalities have structured and legal protections; they can restructure debt; there is state regulation of finances and debt allowances; and municipalities have the power to restructure debt.
Also the federal government can support state and local governments. The federal government can raise taxes and cut spending in pro-cyclical actions. The federal government can also create counter-cyclical stimulus packages.
How bad was the situation for municipal bonds in the Great Depression between 1929 and 1937? Half of all the defaults that ever occurred happened then, amounting to 17.7 percent of outstanding debt, which was $2.7 billion dollars. Some 2.7 percent of municipalities defaulted.
There were five reasons for the severity of the defaults: a severe contraction in GDP amounting to 30 percent in three years. There was a rapid run-up in public indebtedness, as it almost doubled. There was a high delinquency in tax receipts, a lack of public support facilities (many unemployed were forced into the humiliation of begging); and, policy response by the federal government was poor. (There was no safety net at the start of the Great Depression.)
Where does the market go from here? What should investors do? There is considerable uncertainty as corporations are not hiring in significant numbers, and are not buying back stock. Currently there is volatility in rates and prices. It is hard to guess what will be going on down the road.
Larson did not foresee meaningful increase in defaults, although there will be a definite increase in credit downgrades, together with headline risk.
He advises investors to stick with the safest and best opportunities in munis. Invest in A rated or better munis. Invest in state and local GOs. Invest in solid tax-backed bonds. Invest in essential purpose revenue bonds.
To illustrate the relative safety of munis, Larson pointed out figures on a chart that showed that the default risk for a AAA corporate bond at .65 percent was significantly greater than a BBB rated municipal bond at .37 percent.
Larson focused on California munis, offering a number of reasons why residents should invest in them. The economic benefits greatly outweigh the risks. It is the eighth largest economy in the world. California has 12 percent of the U.S. population, 16 percent of the U.S. tax revenue and 13 percent of the nation’s GDP, making it the giant in the national system.
California has a very diverse economic base. The state’s debt per capita is in line with its peers. Servicing of debt obligation is only 4 to 6 percent of revenues in the next three years.
The state’s pension funding is at 87 percent, among the top quartile of states. Bondholders are constitutionally protected, with only education taking priority over bond payments. California municipal rates and spreads are at bargain levels. Conclusion, said Larson, California municipals are a safe investment.
Larson can be reach at the First Private Bank & Trust at (213) 400-4033.
Education Nuggets
By William Parmenter, editor
Dr. Don Gimpel started his five minutes on investor education at the May 15 AAII meeting with an anecdote about lost money.
Let’s say you had a bank account, or a savings and loan account and you closed it out, leaving some money in it. The state controllers office takes the money.
How to get it back? Go to the website at That link takes you to the state controller’s office, and to a place where they have information onold bank, and savings and loan accounts. You have to put in your name and establish your identity to recover your money.
Gimpel also announced the upcoming meeting of the Computer User’s Group from 9 a.m to noon, Saturday, June5in the Garden Room at the Veterans Memorial Complex at Overland and Culver Blvd., Culver City. Steve Hunter is coming from Colorado to present his new UltraFS version 11, a new version loaded with features, that downloads data very quickly. UltraFS, a calendar-based system, gets an annual return around 33 percent.
Questions maybe directed to Don Gimpel at .
Orange CountyAAII Announcements
For information about the OrangeCounty chapter of AAII and their meetings, go to .
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