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Q

With the recent bailouts and apparently more to come, do you think the increased debt will lead to spikes in higher inflation? If so, would you recommend deviating from an income strategy of purchasing long-term municipal bonds that produce higher yields? If so, what strategy do you suggest given our current economic climate and possible significant expansion of future debt?

A

James A. Klotz responds:

Bailouts notwithstanding, the global economy is undergoing a deleveraging process which, in our opinion, poses a greater threat of deflation than inflation. However, in our 35 years in this business, we have never found anyone who could accurately predict the future direction of interest rates for any reasonable period of time, including us.

Experience has taught us that the most successful municipal bond investors are those who purchase bonds when their funds are available and don’t try to “time the market.” There is a tendency for investors to underestimate the cost of the income they sacrifice when making shorter-term investments and the inability to recover this lost income, regardless of how high long-term rates may go, even if they do rise.

As you well know, the difference in income between 2.00% and 6.00% is 200% ,not 4.00%, as many perceive. On an investment of $100,000, one would sacrifice approximately $4,000 of reinvestable income per year.

Further, municipal bond yields are at historic highs right now compared to Treasury yields. Muni rates did not follow Treasuries on the way down and are not likely to be dramatically affected if Treasury rates rise. If anything, they will probably correct to their traditional relationship.