Could Meredith Whitney be right? Is a muni bond meltdown on the way?
Back in 2011 bank analyst Meredith Whitney talked about the huge meltdown in the municipal bond market that was going to occur. Often times in making the calls like this the timing is very difficult.
Back in the days of my trading floor exploits, my nickname was Dr. Given. I would often make calls that were inevitable to happen and the bulk of the times I was right. However, I was always cornered on the timing when it would happen. That is where the vulnerability in the calls come in.
Recently, the VPM models have been dumping just about anything that looks like a municipal bond. The municipal bond market has actually done quite well over the last three plus years since Whitney’s call was made. But now there are several issues starting to show up.
Chicago may be the potential tipping point as it’s been downgraded more than Greece lately. Many of the rating agencies have them rated as negative to junk. Due to recent rulings in the Illinois courts they have made it impossible for counties and other municipalities to file bankruptcy. It will take the legislature to change the laws for these counties to be able to file bankruptcy like Detroit did.
Chicago is just the tip of the iceberg of what potentially lies out in this marketplace for potential disaster in the municipal and high-yield corporate debt markets. The patterns that are showing up across the board in interest rates are continuing to suggest that the markets will see a readjustment of how they have been structured over the last six years during the recovery from the great recession.
As I have discussed many times on the Market Thunder show and in commentary, I believe that the initial rise in interest rates is not likely to cause any material negative effects to the stock market unless they rise too fast triggering concerns with liquidity in the bond market.
I believe it will be very important to watch the developments in these secondary debt markets such as high-yield, corporate, and municipal bonds. This readjustment in interest rates is long overdue. Interest rates have been artificially held down. As I’ve discussed several times in the past, I believe that the dog is finally going to wag the tail. In other words, market participants are going to decide where the interest rates will go next, not the Fed.
There seems to be very few market participants that don’t agree that rates are going to rise. Most of these people are focused on the actions of the Federal Reserve. We have been conditioned over the last six years to think that the Fed is driving the yields and that this is the way it will be from this point forward. In the past this has not at all been the way that the markets unfold. I strongly believe that the market forces will come into play to push yields higher and you’ll start to see a dislocation of capital occur as this happens.
Many have pointed out that even though interest rates are rising, the stock market was able to move higher. But during this period of time, the stock market was much lower in price and configured much differently than it is today. With markets at historical highs, the possibility of the continuation of a strong US dollar, interest rates moving higher, and other adjustments that are occurring in the economy, we are likely to be at a point in history where a substantial turning point can occur.
From my viewpoint, I see a continuation to the upside for stocks in the short run. But in the long run, we are approaching the ultimate top in the stock markets. With municipal bonds currently leading the way on the downside, we are seeing liquidation across the board when it comes to all aspects of the credit markets. One thing VPM is very good at is detecting large shifts in the secular and intermediate trends. It has definitely been telling us a lot about the credit markets for vulnerability in the past several weeks.
While there continues to be probabilities for the stock market to move higher, there seems to be very little probabilities for the continued appreciation in the credit markets. This sets the tone for the final stage of the secular trends as we work through the second quarter of this year.
Yesterday’s action in the stock market was very lackluster as we saw the market move up toward key resistance for the week at the 2137 level with an intra-day high of 2133.02. The markets faded after reaching these new highs to close slightly lower on the session as it traded in a very sloppy sideways pattern into the close.
The configuration suggests that it is critical that the market gets above the 2134.80 level today or risk the probability for a decline back toward the 2118.70 level. Penetration of this level will suggest that the markets will decline further towards 2111/2099.45.
Also, the three-day volatility indicator has dropped below 10. Typically when this occurs we see volatility increase in the next 2 to 3 sessions with the volatility on the downside. The VIX index has traded back down to the low 12 handle at 12.33. This also points to a potential resistance point on the markets.
This being the case, it will be incredibly important for the market to move out of this range and move toward the minor objectives that I’ve talked about between 2154/2166 levels. Failure to get through this level will set the tone again for a decline back toward the previous trading range that we were stuck in for several months.
The market should open flat to higher with a 60 percent probability to close lower should the market remain below the 2134.80 Level today.
Today’s Key Levels