California vs. Corporations: Who’s Outperforming?

Despite the headlines, California paper has handily outperformed the S&P 500! Hard to believe but a six month look back at the iShares California AMT Free Muni ETF (CMF) versus the S&P 500 ETF (SPY) clearly shows that this debt ridden state led by the Governator, has been a better place to invest your money.

With about eight percent outperformance and much less volatility, California municipal bonds have had a great six month run versus the S&P 500. Granted this is a short period of time, but it highlights two key themes moving markets: “too big to fail” and the fear surrounding equities.

Many believe that any state in the Union, particularly California, would be bailed by the Federal government immediately if default or bankruptcy was imminent. That perceived backing, (see certain auto companies and investment banks) has caused California municipal bonds to be in steady demand despite the state’s precarious financial condition. (Greece anyone?) Securities with a “too big to fail” tag are attractive amidst economic uncertainty, especially if they yield more than explicitly backed federal government bonds.

Secondly, most investors are gripped with fear over another equity collapse due to poor economic conditions. To quantify this extent of this fear, examine the record amount of cash on the sidelines and/or the overwhelming exodus from equity mutual funds to fixed income funds. This fear (some say reality) is constantly tugging the S&P downward and will continue to do so — at least until a few red lights on the economic dashboard turn green.

So the market — at least in the short term — has rewarded investors in a debt ridden state, operating with no approved budget since July 1st, (Did I mention a $19 billion shortfall?) over investors in some of the largest corporations in the world who happen to have over a trillion dollars in cash on their balance sheets. Perhaps Warren Buffett said it best, “In the short term the market is like a popularity contest, but in the long term it’s a weighing machine.” It will be interesting to see if he’s right.