Those of you who recall the CB (citizens band) radio craze of the 1970s may recognize the following expression the era spawned: "Keep the pedal to the metal." Its fundamental meaning - push ahead with determination - comes to mind as I consider what I believe is the optimal municipal bond strategy at this time.
Following recent and very thoughtful guest contributions to Muni Nation, I thought it's time I provide my outlook for the remainder of the second quarter. Firstly, I think it is important to take note of the municipal market's performance thus far in 2016 (through April 29). Returns were positive each of the last four months; the market is up 2.42% year-to-date1. The eight consecutive months of cash inflows into muni funds that helped fuel these gains highlight the key fundamentals supporting this market: a modest increase in new bond supply, the historically low default rate2 underlying the majority of issues, and the taxable equivalent yields compared to many taxable alternatives.
Comparative Index Yields (Nominal vs. Taxable Equivalent Muni) As of 5/1/16:
Additionally, I believe that yields should hold at or near current levels even in the unlikely event that the Federal Reserve pushes interest rates higher before the end of the year. I would continue to expect munis to deliver relatively favorable returns.
Invoking the title of this piece, I suggest again: keep the pedal to the metal. Municipals can continue to form an important part of an investor's core strategy in the near future. Investors should not deviate from employing municipal bonds, both tactically and strategically, in their portfolios. Stay the course.
1Source: Barclays. Based on the Barclays Municipal Bond Index. The index is considered representative of the broad market for investment-grade, tax-exempt bonds with a maturity of at least one year.
2Source: Moody's Investors Services.
Yield to Worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
Taxable equivalent yields are used by investors to compare yields on taxable and tax-exempt securities after accounting for federal income taxes. TEY represents the yield a taxable bond investment would have to earn in order to match, after deducting federal income taxes, the yield available on a tax-exempt municipal bond investment. TEY = Tax-Free Municipal Bond Yield/(1 -Tax Rate).
The graph displays the yields of the Barclays Municipal Bond Index and Barclays High-Yield Municipal Index on a tax-equivalent return basis and compares such yields to other asset classes as represented by the indexes described below. Fixed income investments have interest rate risk, which refers to the risk that bond prices generally fall as interest rates rise and vice versa. U.S. government bonds are guaranteed by the full faith and credit of the United States government. Municipal and corporate bonds are not guaranteed by the full faith and credit of the United States and carry the credit risk of the issuer. Municipal bonds are exempt from federal taxes and often state and local taxes. U.S. Treasuries are exempt from state and local taxes, but subject to federal taxes. Prices of bonds change in response to factors such as interest rates and issuer's creditworthiness, among others.
The Barclays Municipal Bond Index is considered representative of the broad market for investment-grade, tax-exempt bonds with a maturity of at least one year. The Barclays High-Yield Municipal Bond Index is considered representative of the broad market for below investment-grade, tax-exempt bonds with a maturity of at least one year. The Barclays U.S. Corporate Bond Index is considered representative of the broad market for investment-grade U.S. corporate bonds with a maturity of at least one year. The Barclays U.S. Treasury Index is considered representative of public obligations of the U.S. Treasury with a remaining maturity of at least one year.
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