In case you haven’t noticed, the municipal bonds market had a small earthquake. It offers a preview for what can happen when a bond bubble deflates.
The epicenter of the earthquake is in California. Although its budget trouble has been known for a long time, investors didn’t mind until last week. What made investors pay attention all of a sudden? Pundits floated all kind of theories — QE2 not meeting expectations, Build America Bonds program ending, Republicans gained seats in mid-term elections, and so on. The truth is nobody knows. It just happened. When it happens, it happens fast.
Here’s the 1-year price chart for iShares California AMT-Free Municipal Bond ETF (ticker: CMF):
After a steady climb for most of the year, it started a nosedive on Nov. 8. All the gains in a year went poof in a matter of a week. Is it just a one-time glitch from which it will recover shortly? Or is it the start of a downward journey? Nobody knows.
The earthquake isn’t limited to California. It also happened at the national level. Here’s the 1-year price chart for iShares National AMT-Free Municipal Bond ETF (MUB):
Same nose dive since Nov. 8. It’s really hard to tell which is which between the two charts.
So far the earthquake has only happened in the munis market. Taxable bonds haven’t been affected as much. Maybe one day those other investors will also wake up and start paying attention to matters that have been known all along. There’s no reason to think it can only happen to munis.
A market going down isn’t any surprise. The speed at which it goes down can be surprising.