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Selecting Municipalities for Investment

(Guest Commentary By Bill Rempel – March 6, 2008)

Dear Subscribers and Readers,

For those who had wanted to learn more about individual stocks, the art of stock selection, and model-based trading/investing, it is again time to see what one of our regular guest commentators, Bill Rempel, has to say.  Bill is a prolific writing on the stock market and individual stocks and is the author of a very active market blog at: http://billrempel.com (“The Rempel Report”).

In this commentary, Bill is going to show us a very creative way to screen for bargains in the municipal bond market – one that involves analyses on a county-by-county basis, as well as investing in individual municipal issues, as opposed to relying on municipal bond mutual funds for investment.  Similar to Bill's commentary last month, this commentary is a little bit more involved than most (although rest assured, there is not much math here).  However, this commentary is a fascinating read, and also acts as a great starting point for those who want to do further research on purchasing municipal bond issues. Without further ado, following is a biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “Turning a Research Paper into a Trading System (TRPITS), Part V” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.


Let's assume for the purpose of argument that I believed munis are a "buy" right now – actually, I'm inclined to believe they are, but I'm a simple system trader – and let's further assume that I had the wherewithal to purchase individual municipal bonds, or lots of them, rather than being limited to buying into municipal bond funds.  How would I start?

There's a parallel here with the search for value in the stock market.  If I were looking for a "value" stock, in addition to a low price-to-yield (dividend or earnings), I might want data that assured me of the financial strength of the company underlying that earnings or dividend yield.  Since a municipal bond's strength is dependent upon the tax base of the municipality, I might limit my search to those areas with signs of strength in the underlying economy which the municipality taxes.

There's also a strong parallel to my recurring theme of using publicly available data in investing.  Not only can I turn a research paper into a trading system, I can use public data to find the municipalities that appear most likely to be fiscally strong, and start from there to potentially screen for the bonds with the best price value.

As a starting point, I am using U.S. Census projections for 2006, the most recent available, to screen counties for growth.  The first thing I'm doing is sorting the counties from largest population to smallest, and grabbing the top 100 (an arbitrary decision, I admit).  Then I will filter those for the counties that, from 2000 through 2006, had total growth in both international immigration and internal U.S. migration (there are 34 of these).  Here they are, sorted by total growth (descending) since the 2000 Census.

U.S. counties populations sorted by total growth since the 2000 Census

I know where a lot of these places are already, but if I didn't, I could enter the county name in Google Maps and get a location; I could view a city and the county lines in Mapquest.com; and then I would pick some city names out of the area.

I had mentioned last week that, according to the OFHEO, home prices held steady over the past year.  I also mentioned that we could spend a great deal of time deconstructing the various indices used to measure home prices – just as we could spend the same amount of time discussing stock market indexing.  Regardless, different areas, with different appreciation rates, combine to form an index.  Since the S&P Case-Schiller index only contains 10 cities (or 20, if used by a "broad"-minded pundit), it's not a good source for searching off the beaten path.  The OFHEO's Home Price Index, however, ranks 291 metropolitan statistical areas, and has data for many others that didn't have the minimum number of transactions to rank.  The ranking starts on page 32 of the report.  I can now reference the largest cities in the counties with the most growth.

I can then go to the U.S. Census' "Factfinder" page and enter a particular city name to see different levels of demographic data for that city.  Some of these will be a little outdated, but there are other sources for this data, namely, Realtor.com's "Neighborhood Search"

It's plain to see that with a little supposition about what's important to municipal theft-base, er, tax-base growth, I can use publicly available data to find a group of municipalities that have solid population growth, robust property value growth, high per capita income, and strong economic prospects.  All that remains is for me to apply this data to screen out the most promising municipalities, and then search for those presenting the best value in terms of yield.

Collin County, Texas is tops on the percentage growth list on my 34 screened counties, and is most likely considered part of the "Dallas-Plano-Irving" MSA according to the OFHEO.  This MSA ranks 97th of 291 in the survey, with 2.95% home price appreciation over the last year, and 15.82% cumulative appreciation over the last five years.  This area doesn't appear to be in a slide now, and doesn't appear to have been in a bubble recently.  Plano is a strong town to be considered.  When viewing the demographic data at Realtor.com, I can click the "Income" tab and note that Plano has higher income on average than the D/FW area as a whole (I think they've got a typo on the "median" cell).  I can view the Lifestyles tab and check out the types of population groups living there, according to Claritas categories.  It's a white-collar area with a lot of tech and services jobs, and with a growing emphasis on driving sales tax revenues through attracting retail business.  I could also check out other Collin County locations like Frisco, Allen, and McKinney for the same types of information.  Or, I could be satisfied with finding what I think is a low-risk municipality in this county, and move on to screening some of the other 33 counties that I've identified as possibilities.

Denton County, Texas, made famous by the Rocky Horror Picture Show, is right next door to Collin County.  The closest MSA is Fort Worth-Arlington and the largest city is Denton.  Statistics for home price appreciation are similar, rank 101 of 291 with 2.89% one-year and 17.43% five-year appreciation.  Denton is younger and hipper than Plano.  Having Collin and Denton Counties at the top of the list is a real Texas Two-fer.

Will County, Illinois, is southwest of Chicago – think "Joliet Jake."  The Chicago-Naperville-Joliet MSAD is ranked 152 of 291, with 1.62% one-year and 40.78% five-year growth in home prices.  These are right about in line with the U.S. average, and represents a bit more of a slowdown than I saw in the counties just north of D/FW.  Joliet itself may have different home price appreciation characteristics than the entire MSAD, as it's the fastest-growing city in the U.S. midwest.  It's cheaper and lower-income on average, a satellite city that gets commuted from, not to, and it's an ex-industrial town that's getting a bit of revitalization.

The end product of the process will be a list of municipalities that I can choose which ones I'm comfortable with, and I can scrub this list against a list of available muni bonds to determine what I believe presents the most value.

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