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I have sold off about 85% of my municipal bond fund portfolio over the last few months, moving much of the proceeds into one or another form of dividend equities (some of which are, like bonds, interest-rate sensitive). In other words, I have traded one form of risk for another.

Like anyone who ever owned Puerto Rico debt, I have grown to recognize that default risk exists even in muni bond land. In addition, the threat of interest rate "normalization" has made me aware of the risk that a 30-year bull market in muni bonds is not guaranteed to last forever.

However, there is one muni bond risk I have just not considered - until I read about the strange case of Illinois. That is the risk of possible over-issuance (or a flooding of the muni bond market). For my entire adult life, the supply of muni bond issuance has always been greeted by an equal or greater demand for tax-free municipal bond debt by hungry bond investors.

The following linked Bloomberg article suggests that the oddly Puerto Rico-like State of Illinois is considering a "shock and awe" approach to issuing a record-breaking massive amount of muni bond debt precisely at a time when folks like myself are fleeing the bond market in droves.

Illinois Ponders Pension-Fund Moonshot: a $107 Billion Bond Sale

Lawmakers in Illinois are so desperate to shore up the state’s massively underfunded retirement system that they’re willing to entertain an eye-popping wager: Borrowing $107 billion and letting it ride in the financial markets.

The legislature’s personnel and pensions committee plans to meet on Jan. 30 to hear more about a proposal advanced by the State Universities Annuitants Association, according to Representative Robert Martwick. The group wants Illinois to issue the bonds this year to get its retirement system nearly fully funded, assuming that the state can make more on its investments than it will pay in interest.

It would be by far the biggest debt sale in the history of the municipal market, and in one fell swoop would be more than Puerto Rico amassed in the run up to its record-setting bankruptcy.

“We’re in a situation in Illinois where our pension debt is just crushing,” Martwick, a Democrat who chairs the committee, said in a telephone interview. “When you have the largest pension debt in the world, you probably ought to be thinking big...”


https://www.bloomberg.com/news/articles/2018-01-26/illinois-...

I am thankful to have been clued-in to this possible issuance now, rather than after the new debt is floated. It gives me a bit of time to unload most of my remaining muni bond fund shares before the market has a fast and big yield adjustment in the form of abrupt downward price pressure.

At this point, those of us who depend upon interest, dividend and pass-through income are being forced into fewer and fewer asset classes. Bond funds are just not worth the risk of share price erosion until after interest rates have fully "normalized" and/or until a major price correction or over-correction occurs. At some point (who knows when), muni bond funds with low default risk will reach a price level at which the yield is so great that jumping back in makes sense.

Until then, we either have to sit on and deplete our cash (living off our "seed corn"), or else try and find some equity shares with prices that have not become so inflated that the dividend, distribution and/or pass-through yield is not adequate compensation for the "bond proxy" price adjustment that may come as central banks raise rates or unload assets.

One way or another, interest rates are bound to self-normalize, I think, given the unexpected wave of cash flowing into the pockets of workers across the US. Full employment, augmented by the corporate tax rate reduction, appears to be fueling precisely the sort of inflation that central bankers fear most: wage inflation.

Along with income-dependent investors across America, I am concerned about how risky my income assets have become, from any of the following classes, all of which are represented in my ETF, CEF, individual share and mutual fund porfolio (in no particular order):

1. Tax Free Muni Bonds
2. Preferreds
3. High Dividend Stocks
4. Energy MLPs (including pipelines)
5. Business Development Companies
6. REITs
7. Metals, Mining & Commodities
8. Oil companies
9. Utilities
10. High Yield Emerging Market Sovereign Debt

Scary.
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