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come from the states, may be underestimated. A 2011 analysis by the Joint Economic Committee shows that lower portfolio return assumptions on pension assets sharply increase the magnitude of underfunded pensions (see chart, right). AS reported unfunded state pension and OPEB liabilities State and local unfunded pension liabilities under Billions, USD different portfollo return assumptions, Trillions, USO 1,400 3.0 1,200 25 1,000 20 800 1.6 600 1.0 400 300 05 o 0.0 2001 2003 2005 207 2009 a% Return 6% Return 5% Retuin 4% Return Source: State Comprehensive An nual Financial Reports. Source: CBO, Center forRetirement Research. However, there’s more of an effort at the state/local level to address this issue than at the Federal level. More than 40 states lowered pension benefit liabilities over the last 3 years according to the National Conference of State Legislatures. Measures taken include raising employee contributions (while lowering employer payments), raising minimum retirement ages, cutting post-employment healthcare benefits and in some cases, switching to defined contribution from defined benefit plans. The good news, to paraphrase Mark Twain, is that reports of municipal bonds’ demise have been greatly exaggerated. From 1970 through to the end of 2011, municipal bonds rated by Moody’s experienced a grand total of 71 defaults among 17,700 issuers (11 of which occurred during 2010 and 2011). General obligation bonds accounted for 5 defaults; 29 were related to housing; 22 for hospitals and healthcare; 3-4 each for education and infrastructure. Utilities and cities registered 2 each, while counties, special districts, and water & sewer and experienced | each. The average recovery for defaulted munis was 65%, compared to 49% on corporate senior unsecured bonds. Last comment on municipals: while /oca/ tax collections are weak due to the collapse in home prices, state tax collections have been increasing for 7 quarters in a row. State and local tax revenue US mutual fund flows Percent, YoY change of 4-quarter moving average Billions, USD 20% 1.000 15% 800 10% Local si a 400 0% 200 7% Oo -10% Stat -200 15% 400 Equities 2004 4005 2006 2007 2008 «8609 62O UDI 2007 2008 2000 2010 2011 2012 Source: US Census. Source: Invesiment Company Institute. OK, so the US economy is improving, but is still heavily dependent on monetary and fiscal stimulus to grow, and the only belt-tightening one can find is at the state and local level. Since 2009, after equities collapsed and bond prices rose, how have many investors reacted? By selling more equities and buying a lot more bonds. See chart above (a global version of this chart looks roughly the same). Have investors been positioning this way since stocks are expensive? Not really. Insert a giant martini glass on the chart below from 1998 to 2001 (I hate using simple averages which include periods when the market had lost its collective mind). The current P/E multiple is in the middle of the ex-bubble range of the last 25 years. Some bank stocks look interesting, even after accounting for reliance on shrinking loan loss reserves to HOUSE_OVERSIGHT_025238