We mentioned earlier how in the Jeff Gundlach profile in Barron’s, the star bond manager was calling for a collapse in the muni bond market.
But you should bear in mind that there’s a subtlety to his outlook. He’s not predicting a wave of defaults. He’s predicting a wave of panic.
Here’s what he says:
What makes the $2.7 trillion muni market particularly vulnerable, Gundlach says, is its weak psychological underpinnings. Many investors in municipals are wealthy individuals who buy the securities purely because of their tax advantages and have little knowledge of the fundamentals of the paper they own. They tend to be “all-in” investors, owning little else, and thus will be prone to panic, he figures, in the face of surging defaults.
“Look, I don’t know whether the market will suffer $10 billion or $30 billion in defaults, but the actual amount doesn’t matter, Gundlach says. “There will be a panic at the margin, and muni bonds from the highest-rated on down will plummet, in part because other sorts of investors tend not to step in.”
As such he’s creating a venture to scoop up closed-end muni funds when they collapse.
What he’s planning on doing is what we predicted would happen last month. Those spreading muni doom, like Meredith Whitney, are pushing investors out of the market, and encouraging them to sell their assets at a discount to the sophisticated investors like Gundlach. The smart money wins, and cities end up paying marginally higher yields thanks to the fact that institutional investors aren’t tax-advantaged the way mum & pop are.