My stock pick for May is a closed end fund that invests in municipal bonds in Pennsylvania, the Invesco Van Kampfen Pennsylvania Value Muni fund (symbol VPV). Since the start of 2011, investors hae been wary of putting too much money into municipal bonds, particularly after some of the predictions of increasing defaults made by some pretty big names. Instead of defaults, however, we have been seeing state after state manage to close their budget gaps by slashing spending or, in a few cases, raising taxes. Now, the stars are aligning in a way that ought to make munis in general and VPV in particular the place to be for some of your portfolio.
First, the Fed has made clear that interest rates are going to stay low for at least the rest of this year. To be clear, the Fed is talking about short term rates, so the actions by the Fed is not going to hold rates for long term munis steady, only the rates for short term instruments. A fund like VPV, however, is leveraged to the extent of about 25% of total assets. By keeping the short term rates at next to nothing, the Fed is reducing the cost of that 25% financing to next to nothing as well.
Second, the level of uncertainty in the economy is rising. Economic growth stagnated in the first quarter and the price of energy has continued to soar through April. Unemployment claims keep rising. Inflation is strengthening. Even the Chinese economy may be about to slow down. Indeed, we may be watching the start of the second leg of a double dip recession. On the other hand, the economy may prove strong enough to withstand all of these upsets. A budget deal may be reached that results in an increase in confidence and economic growth. In other words, even more than usual, it is difficult to predict the direction and speed of the economy. In my view, it is not a great time to deploy more assets into the equity markets.
Third, right now, VPV is paying a return of 7.21%. This is free of federal tax (unless you pay the AMT, in which case about 10% of what you receive is subject to that tax, making the tax rate 2.8%). VPV is also selling at a discount of 4.95% from net asset value. This means that the bonds owned by the fund are worth about 5% more than the stock price. Since these discounts tend to move towards zero, there is an upwards push on the stock price which results. VPV also has about four months of earnings socked away which can be used for future dividends. This greatly reduces the likelihood that VPV will reduce its dividend in the next year barring major market upheaval.
Fourth, Pennsylvania has the major benefit of the Marcellus Shale drilling and production to help it meet state and local financial needs. Drilling in this enormous field is estimated to add about 100,000 jobs in Pennsylvania by year end. It is also estimated that economic growth in the state will be about 1-1.5% higher than otherwise just due to the drilling/production activities. What this means is that state and local expenditures will be reduced in the Keystone state at the same time that revenues rise from the increase in incomes. Simply put, this will make the likelihood of default by Pennsylvania localities much less.
Fifth, the city of Harrisburg, Pennsylvania’s capital, is facing some severe financial problems due to construction of a local facility that is draining city coffers. For the moment, this continues to cast a bit of a pall over municipal bonds from Pennsylvania. A default by Harrisburg will have no effect on the other state municipalities, however, so the price depression represents something of a buying opportunity.
VPV is not a home run kind of investment. Rather it is an appealing place to put funds at the present time. It will provide a nice tax-free return with much lower risk than most stocks.
Disclosure: I am long VPV.
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