It’s hard not to notice the slamming endured by the municipal bond market over the past few months. Many advisors discussed with clients a scenario in which bond pricing would gradually decline as interest rates gradually moved up. The reality was that the 10-year Treasury yield jumped over a full percent from May to June and municipal bond prices plummeted quickly. Fund investors who don’t hold bonds till maturity likely felt the pain even worse as high levels of redemptions combined with lower prices caused some municipal funds to drop 10% or more, particularly those that own longer-dated bonds. Factor in the Detroit bond crisis and cover story by Baron’s a few weeks ago slamming Puerto Rico and the picture for municipal bonds becomes even bleaker. But savvy investors must always be tracking struggling asset classes to find the point at which value starts to present itself.
As they often due, investors may have overreacted to the rapid rise in Treasury rates. With the financial media constantly pushing equities as a ‘hiding place’ and encouraging investors to find yield from stock dividends rather than bond interest, investors sold off huge amounts of bonds in favor of stocks and cash. The incredible amount of bond redemptions forces fund managers to sell securities quickly. That has an adverse effect on bond prices and often leads to more selling as investors become discouraged with poor fund performance. Over the past week or so prices have stabilized a bit and the financial media has started to talk about municipal bond investments offering 4-6% tax-free yields as compelling opportunities. Rather than hearing about how poor a state’s finances may be, we’re hearing that the problems may be exaggerated, that default rates are very low, and that anyone who didn’t see the Detroit crisis coming must have had blinders on. Essentially we’re hearing and reading more that certain segments of the municipal bond market present compelling investment opportunities at today’s prices.
Further encouragement is offered by the spreads between triple A municipal bonds and Treasuries, with municipal bonds coming out way ahead at today’s prices. Let’s not forget that municipal bond investors are typically high earnings individuals and families that buy municipals over other asset classes because their tax brackets are high and they want the tax-free yield. For that reason, you will likely see buyers come back in to snap up these attractive yields, especially from parts of the market which may be in an oversold position. I don’t think any of us expect tax rates for the wealthiest Americans to go down in the next few years, a scenario which could make municipals less attractive versus some other asset classes.
Several pieces of recent press from Forbes, Financial Advisor Magazine, and Bloomberg have suggested digging around for bonds with shorter durations (perhaps 3-6 years) and staying within the investment grade space but not necessarily triple A.*
As always, feel free to reach me with any questions or concerns.
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Investing in municipal bonds involves risks including, but not limited to, interest rate risk, credit risk, market risk, inflation and high-yield risk, and possible loss of interest on out of state bonds and dividends paid by national funds may be subject to state and local taxes. Income may also be subject to the Alternative Minimum Tax.
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*Financial Advisor Magazine: September, 2013: “Is it Time to Buy Munis”