A Case For Municipal Bond Optimism

| About: iShares National (MUB)

Very much like hitting a modern day "reset" button, the outlook ahead for the municipal market should be viewed in the light of the factual evidence, which I argue supports a return to optimism for the municipal asset class. Despite the post-election selling and volatility which has occurred broadly in fixed income, I view this tumult as a short-term market correction. Viewed in the context of the details below, I believe that the muni asset class has not been as attractively valued in the 10-30 year maturity range since back on June 24 and March 17 of this year. Right now, as shown in the following table, 10-30 year AAA-rated munis currently are yielding more than U.S. Treasuries. Prior to this period, October 2015 presented a similar valuation opportunity and marked the beginning of a year of positive performance for municipals, and the start of more than 50 consecutive weeks of inflows into municipal bond open end mutual funds and ETFs, according to Morningstar® data.

Triple-AAA Rated Muni Yields as a Percent of U.S. Treasury Yields

AAA Muni vs. U.S. Treasuries

11/25/15 - 11/25/16

11/25/2016

Maturity

Min

Max

Mean

Yield Ratio

1 Year

56.30%

136.36%

94.62%

111.67%

2 Year

65.63%

118.47%

84.81%

98.48%

5 Year

65.20%

100.81%

79.55%

91.92%

7 Year

68.49%

99.31%

81.16%

91.16%

10 Year

80.65%

103.21%

92.09%

101.76%

15 Year

92.26%

115.31%

102.74%

109.86%

20 Year

95.57%

118.07%

105.48%

111.36%

25 Year

91.67%

116.97%

102.80%

108.08%

30 Year

86.10%

110.18%

97.34%

103.82%

Click to enlarge

Source: Siebert Cisneros Shank & Co.

When considering the supply and demand dynamics, the projected December 2016 cash flow of $35 billion from maturing bonds is expected to be the largest amount ever in any December in the history of the municipal bond market. The second largest volume occurred in 2012 when $32 billion flowed back to investors from calls and maturing bonds. If you include coupon payments, the total amount of reinvestment cash that will likely be available at the end of December is approximately $46 billion.1 This should place enormous pressure on supply. Even if only half of the reinvestment cash is deployed back into munis, demand would be well in excess of supply. According to the Bond Buyer, today's 30-day visible supply2 stands only at $16.785 billion.

Given the promising data, I believe December may potentially be a rebound month for the asset class.

1Source: Siebert Cisneros Shank & Co.

2The 30-day visible supply is compiled daily from The Bond Buyer's Competitive and Negotiated Bond Offerings calendars. It reflects the dollar volume of bonds expected to reach the market in the next 30 days. Issues maturing in 13 months or more are included.

The S&P rating scale is as follows, from excellent (high grade) to poor (including default): AAA to D, with intermediate ratings offered at each level between AA and C. Anything lower than a BBB rating is considered a non-investment-grade or high-yield bond.

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All indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a fund. An index's performance is not illustrative of a fund's performance. Indices are not securities in which investments can be made.

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Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer's financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

Diversification does not assure a profit or protect against loss.

Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a fund carefully before investing.