Time For The Year End Municipal Bond Strategy

We are fast approaching the end of another year. Most traders understandably wind down their activity during this time period. The low volume trading days that will accompany the next few weeks don’t offer the best opportunities. But there is one strategy that is available only once at this time of the year and it offers an incredible opportunity that can’t be missed.

I’m referring to my favorite Year End Strategy.

Follow the link to read about the strategy in detail. The guide I’ve put together includes multiple real trades that I did that year. The percentage returns may seem small but the high ratio of profitable trades as well as the short time frame multiplies the returns to an awesome per annum return.

In short, the strategy takes advantage of the ‘weak hands’ that usually dump very valuable shares during the last few weeks of December. If you know where to look, you can find shares that bounce right back and continue to rally into the new year. I outline in detail the best places to look in my guide.

One of these is the municipal bond market. This year offers an interesting twist on this strategy. Several months ago I thought that this year would be a dry spell – the same as last year. While this is a fantastic strategy, it requires a certain environment to work. With last year’s huge rally in anything that offered yield, there was no losses.

This strategy is tailor made for the sadist in all traders. After all, for this strategy to work, we need these bond funds to have fallen and produced as much pain and paper losses as possible. These paper losses are then realized for tax purposes.

So I was thinking that with the bull market rally in municipal bonds, this year would not provide any chance for this year end strategy to work. Then came the sharp reversal of fortune for the municipal bond market in November. That shook things up and pushed many municipal bond funds into the red.

From their top in October 2010, municipal bonds fell 8% into December, as measured by the iShares S&P National Municipal Bond Fund ETF (MUB). Individual municipal bond trust funds that trade on the NYSE fell much more than the index.

I believe that this presents us with a great opportunity. If you haven’t already, take a look at the guide in the Year End Strategy and start to make up your own buy list. The municipal bond funds are a great place to start but there are other areas of the market you can also look at.

Usually for this strategy we don’t need the sentimental stars to align. But the negative sentiment is palpable when it comes to municipal bonds right now. According to Lipper FMI retail investors’ flow into municipal bond funds is showing nothing but full blown panic. This year, retail investors were adding between $200-800 million a month to the municipal bond market. That suddenly changed in early November 2010.

The inflow slowed to a trickle and then became a massive outflow. Retail investors withdrew almost $3 billion in the week of November 17th 2010. Then the next week (November 23rd) $2.3 billion and just this past week $2.7 billion. In the past 5 weeks they’ve withdrawn $8.8 billion from this sector. That is about half of the total inflow for the whole year!

Thanks to the recency effect, the Harrisburg municipal bond default is on everyone’s mind and effectively terrifying pensioners half to death. But municipal defaults have happened before and the world has not ended, nor has it affected the municipal bond market:


Source: Prof. K. Deal, Auburn University

Clearly, this is a grossly exaggerated reaction but par for the course when it comes to retail investors. They usually pile into a sector and then flee it at the slightest sign of trouble. As well, when you have smart mavens like Jim Grant buying when retail investors are selling, you know there is an inflection point somewhere close at hand.

There is also the fact that Bill Gross has put $17 million of his own money into bonds. That’s chump change for Gross but he does have a point. The bond market in general is also close to an inflection point. I’ll write about that in more detail next week. In the meantime, this municipal bond shakeup is offering us a juicy opportunity into the year end and after new year’s.

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3 Responses to Time For The Year End Municipal Bond Strategy

  1. Pingback: An Intermediate Low For Treasury Bonds Is At Hand | tradersnarrative

  2. Pingback: Sentiment Overview: Week Of December 24th 2010 | tradersnarrative

  3. Pingback: Sentiment Overview: Week Of December 31st 2010 | tradersnarrative

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