Muni Bond ETFs: Defogging Lenses Required

ETF Trends

The various “cliffs” that we, and virtually the entire business community, have discussed and feared since last November, seem to have appeared suddenly and viciously, sending markets careening toward the fog of uncertainty.

The market fall recently not only took many professionals by surprise, it seems to have cast the outlook into a curious state of confusion. I say that because, prior to the announcement (misinterpreted, in my opinion) last week by the Fed, economists and strategists were generally in agreement on the outlook for the markets and economic growth. Now, those views seem to me to be as difficult to grasp as a handful of Maine fog.

Everyone has an opinion about why or what has happened. Uncertainty, however, is a mighty force which, in the case of muni investors, may cloud decision making. I offer what I consider to be some fog-piercing data points below that I hope make clear some essential realities muni investors can use to rebuild confidence. [Muni Bond ETFs on the Mend]

  1. In contrast to the sell-off in fixed income, I believe continued growth of the economy further enhances credit quality of most municipal issuers.
  2. With CPI at 1.7%, I believe the “real” rate of return on municipals now is compelling. 10–year AAA muni yields at 2.80% deliver more than 1% of inflation-free income . 30-year AAA bonds yielding 4.13% now offer nearly 2.50% of  inflation-free income . 1
  3. The yield ratios of AAA munis to Treasuries — except for 5 years — are all well over 100%, which may attract traders or even corporate investors, potentially setting a floor to recent declines. 2
  4. I think the sudden rise in rates may postpone many new issues , which could reduce the strain on Wall Street balance sheets and free up room to provide more liquidity.
  5. As now seen through clearer lenses, the spreads — the reward for the risk premium of different rated issuers — are now more appropriate, in my view, than any time since the crash of 2008.

I believe all of the above suggests that now is NOT the time to abandon municipals as a core strategy.

James Colby is a portfolio manager and senior municipal strategist at Market Vectors ETFs.

1 Consumer Price Index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households. AAA yield minus CPI equals inflation-free income. Source: Bloomberg as of 5/31/13.
2 AAA Municipal Market Data (MMD) curve as of 6/21/13.

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