Muni Selloff: A Preview of Deflating Bond Bubble

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.

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  1. Chuck says

    I have a ton of munis and I knew this day (week) was coming eventually. While the capital loss is disconcerting, the yields were starting to get to the “not worth it” level. I’ll be glad to reinvest at the new yields for the next 15 years.

  2. Harry Sit says

    Jonathan – Try VCITX, the longer term California fund, or VWLTX, the longer term national muni fund. Same build-up, then a nosedive. Although the name of those two funds say long term, the term isn’t that long. Average duration is about 7 years. The intermediate term funds have shorter duration, which helps.

  3. theo says

    Yep I was just seeing the same with the NY Long term muni (VNYTX).
    The Vanguard total bond index fund (VBTIX) also had a mini-crash, giving up about a third of the 1-year gain in the last 10 days.
    There was a chorus of investment managers that has been warning of the impending bond crash and I did sell nearly half of my bond funds 2 weeks ago (wish I sold it all now 🙂

    According to what I read though, you get back your losses by holding the bond funds for the length of your fund’s duration (because of the expected higher yield on the bonds in the fund)…

  4. cb474 says

    I always feel like a chart like this should include a comparison to the S&P 500, just to put into context the nature of the volatility.

    When someone looks at a chart like that, out of context, and reads the description “nosedive,” it’s easy to interpret that as some kind of radical crash. Whereas, even compared to relatively normal S&P 500 volatility over the last year, suddenly the “nosedive” looks pretty mild. And if you compare it to a real stock market crash, like in 2008, the muni “nosedive” almost seems like nothing more than a blip.

    Also, if you run that chart for the iShares California Muni ETF back a couple years, rather than stopping in late 2009, the “nosedive” starts too look like not unusual volatility, even for munis. One might even start to wonder, where’s the bubble really?

    Out of context it all too readily becomes a bit alarmist.

  5. Harry Sit says

    cb474 – Everything is relative. If someone runs fast, you say “you run fast.” You don’t say “you can’t run as fast as my car.” Stocks are volatile. People know it and expect it. Bonds are not nearly as volatile. When they ramp up slowly over a year and then lose ground in a few days, it can be a surprise. I didn’t say you shouldn’t buy bonds because of this. When you know what can happen – a preview – you are prepared and you won’t be surprised. Perhaps you already know and you are prepared. Not all do.

  6. cb474 says


    I guess it depends who the audience of your blog is. If it’s savy investors who understand how to interpret these things, then the post about munis just provides an interesting perspective on recent events.

    If it’s people who don’t entirely know how to interpret these things, then language like municipal bonds taking a “nosedive” can cause people to panic (and do we really need more panic in the world of investments?).

    I suspect your audience has both sorts of people in it.

    I also personally think that providing some context is always relevant. Information in isolation of context is more just information for it’s own sake, than something which leads to understanding. You can dismiss that by saying “everything is relative” (a truism that can alwasy be said about anything), but what’s the alternative? Never provide any context? Isolate bits of information to the point of meaninglessness?

    Given that the financial media is already so prone to not give people context, not provide understanding, and play off of emotions (in order to get attention), why add to that?

    But the chart of recent muni performance in the post to me seems designed for maximum emotional impact. It isolates out a part of muni performance in order to create the appearance of a slow increase followed by a sudden seemingly unprecedented radical drop.

    Then there’s language like “bond bubble”; “nosedive”; “when it happens, it happens fast”; “went poof in a matter of a week”; “earthquake.” I don’t see how you can say that kind of language is not designed to play up the drama and emotions.

    I like this blog. I’m not trying to rag on it or anything. Al I said was that I think charts like the one you showed would do well to have a little more context, for people to understand the nature of the volatility better. Is that such a radical suggestion?

    In contrast, Larry Swedroe has a article today downplaying all the hysteria about municipal bonds:

    Swedroe has also criticized the “bond bubble” idea in the past. I think Swedroe does a real service by trying to be one of the few people to provide context for these matters, help people understand things, and downplay the emotions.

  7. cb474 says

    P.S. I totally agree with your point that when people have a preview they’re better prepared for the ups and downs. Again I just thought a little more context would also be helpful. I don’t see the two points as in opposition.

  8. Harry Sit says

    cb474 – Thank you for your comments. Those are very fair. I happen to have a pet peeve against comparing bonds to stocks. Although the recent price movements would be a common occurrence in the stock world, it’s not so common in the bond world. It is a big deal in its own domain. I agree with Larry Swedroe on munis. I increased my muni holdings after the recent selloff.

    Outside of munis and TIPS, I’m with Allan Roth, who wrote today in The Bond Party is Over:

    “In my opinion, many investors are in denial that the party is over, and are taking a few more shots of the bond nectar by buying lower quality and longer duration bonds.”

    When better alternatives are available to retail investors, namely FDIC insured CDs that pay just as much or even more, people should be aware of the risks in nominal bonds.

    That’s the context for this post.

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