Thursday, November 6, 2008
Your taxes are going up.
It really didn't matter who won on Tuesday. Whether it was McCain or Obama, your taxes were destined to go higher. Obama, at least, told you it was going to happen.
And now President-elect Obama is armed with the mandate from the "have-nots" to take away from the "haves." So you need to do something to protect your investment income from taxation.
You need to buy municipal bonds.
That advice probably seems strange coming from a person whose investment focus is on growth and speculation. But municipal bonds, which pay tax-free dividends, are clear ground in this market filled with minefields.
That is, if you do it right.
Individual municipal bonds don't offer a high enough yield to protect you against the possibility of default or against the possibility of higher interest rates. But closed-end municipal bond funds are trading with such high yields and at such large discounts to net asset value, they offer the best buying opportunity in 24 years.
Let me explain...
In February 1994, the Fed surprised the market by raising interest rates. Bonds sold off on the news. And the average bond fund was down over 30% by October 2004. Municipal bonds were hit especially hard. And many closed-end municipal bond funds had suffered so much damage, they were offering yields above 6% and were trading at 10% discounts to net asset value.
In other words, investors could buy these funds for 90 cents on the dollar and capture 6% returns in the process.
So despite my penchant for option trading, I advised my clients to buy closed-end municipal bond funds. And we made 25% in six months.
The exact same opportunity exists today. Municipal bonds, along with nearly every other credit instrument, have sold off hard over the past few weeks. And cash-heavy investors have a terrific shot at capturing huge gains.
For example, California investors can buy shares of Nuveen California Insured Premium Income Fund 2 (NCL) at $10.80 per share. The fund pays about 6.5% in dividends, which is both federal- and state-tax free for California residents. And it trades at a steep 12% discount to its net asset value of $12.29.
The 6.5% dividend is more than six times what you'll get in a money market fund. And after taking into account 31% federal tax and 11% California state tax, the taxable equivalent yield is closer to 11.5%.
In other words, rich California investors need to generate 11.5% returns on a taxable investment to equal the same dividend yield on NCL.
In addition, you have the opportunity for capital gains as the discount to net asset value decreases. In 1994, investors made 20% capital gains as NCL rallied from $8.25 per share to over $10 per share in just a few months.
The discount to NAV is similar today. So investors will get a 6.5% tax-free yield and will profit as the stock closes in on its discount to NAV.
This is the best fixed-income opportunity I've seen in 24 years.
Rich people need to take advantage of it.
Markets fall on Obama victory... Dow down 2.8%, S&P 500 drops 2.9%.
Infrastructure giant Quanta Services gets clobbered on weak earnings... down 20% to a new 52-week low.
Medical landlords Kindred Healthcare, Ventas, and Tenet Healthcare hit new lows.
Earnings today... Anheuser-Busch, CB Richard Ellis, Fluor, Icahn Enterprises, Steinway Musical, Blackstone Group, Toyota Motor, Walt Disney.