By Rick Glaze

The major indexes finished strong on Friday but down slightly for the week. The Dow Jones industrial average as well as the other measures of the market closed down less than 1 percent. Oil retreated to $63 a barrel and strength was noted in metals, machinery and building stocks.

Many bond investors remain confounded as the longer-term bonds have refused to post higher yields in the face of continued short-term rate increases by the Federal Reserve. At this writing, the Fed is expected to raise the short rate a quarter point this week.

Low inflation and controlled economic growth have created an appetite for the longer bonds at this yield level.

Meanwhile, the general obligation bonds of the State of California have firmed up as the rating agencies see solid economic growth and a continual turnover in real estate moving the tax base beyond the Proposition 13 limits. General obligation bonds are backed by the taxing power of the state and could be analogous to a personal guarantee from an individual. In the early 1980s, these bonds carried a triple A rating, the highest given.

Just prior to the recall election and Gov. Arnold Schwarzenegger’s election, the Cal bond garnered a rating of triple B, one step above a junk bond rating. With the Legislature overspending by $40 billion to $50 billion, a bungled energy crisis and no plan whatsoever for reform, it was nearing a crisis for the bonds. Today the bond rating is single A and the citizens of California have an opportunity to finish up the job of the recall by passing Prop. 76, which proposes to limit state spending.

Pretend you are a rating agency and look at scenario No. 1: During the last few years of the economic boom, the state’s revenue increased by more than 50 percent, yet for every dollar of revenue, the state spent $1.09 in 2001, $1.05 in 2002, $1.03 in 2003 and $1.07 in 2004. Further, automatic spending for education and other entitlement programs ties the hands of officials and eliminates most of the opportunity for managing the finances, while no provisions for a rainy-day fund exist.

Scenario No. 2: the State spending is limited to the last year plus the previous three years’ average revenue growth. All excess revenues will be used for budget reserve, roads and highways, school and public building construction and debt repayment. When the budget is not balanced, the governor can reduce spending when the Legislature fails to act, thus assuring sound fiscal management.

So, rating agents, who gets a good rating and who gets a junk rating? Recent polls show Proposition 76 with a 49 percent yes vote.

Rick Glaze is the president of Glaze Capital Management of Los Altos and is a registered representative of and offers securities through First Allied Securities Inc.