With all of the democratic revolutions occurring in the Middle East, our decision to reduce international exposure appears appropriate. These events remind us of when the Berlin Wall fell and the U.S.S.R. disintegrated into Russia. Democratic revolutions can have a domino effect just as we have seen in Tunisia, Egypt and Libya (similar to East Germany, Poland, Hungary and Czechoslovakia in the 1980’s). Democracy spreading throughout the world is a good thing, but the time it takes to transition from a dictatorship to a democracy usually has a negative impact on economic activity.
This past week, Adam and I attended an economic presentation by William Strauss, Senior Economist at the Federal Reserve Bank of Chicago. In summary he says all signs point to increased growth in the U.S. Whereas the Blue Chip Economic forecast consensus sees 3.5% growth, he sees 4.0% growth (and even a little stronger in the Midwest). Unfortunately, fourth quarter GDP was revised down last Friday to 2.8% from 3.2%. The largest drag on the number was the decline in state and local government spending.
That is a good segue to the municipal bond market. Last month we talked about the volatility in the muni bond market. The current stalemate going on in Wisconsin and Indiana, appear to be a tipping point regarding state finances. Believe it or not (in conversations with Illinois State Senator Ron Sandack from Downers Grove and Doug Whitley, President of the Illinois Chamber of Commerce), even Illinois is likely to address government spending including pension reform. It is unlikely that collective bargaining rights will be attacked in Illinois like Wisconsin or Indiana because 97% of Illinois’s government workers are already in unions. Regardless, the legislature is likely to write some laws addressing the state’s huge unfunded liabilities. Ultimately this is good for the municipal bond market, but will continue to subject it to headline risk and therefore continued volatility.