Muni Catchup 8/22
by Pat Luby
The Caution Flag is Up!
￼At the beach last week, the waves weren’t intimidating, but a stiff wind was pushing a very strong current, so the lifeguards had the yellow flag up–meaning it was ok to go in the water, but with caution. Some swimmers stayed on the beach while I was out riding waves–but even as an experienced and strong swimmer, I made sure that I was within the bounds of lifeguards’ markers.
Nobody puts up flags in the bond market, but maybe they should. Rates have been bouncing around, though not with as much volatility as we have seen in recent months. The greater concern comes from the “weather.” Is the Fed going to be a headwind or a tailwind? How about GDP, inflation and the Presidential election? The winds around all of these have been shifting back and forth.
This doesn’t mean that you have to be out of the market, but it does mean that you need to be cautious.
Demand is Strong
With the shifting winds, it seems that almost every day someone is announcing their dislike of bonds as an investment class. Yet, investors continue to move assets into the muni bond market. Year to date, over $47 billion in net new money has flowed into muni bond mutual funds and ETFs. (See the Context page for details.)
What’s going on? Why are so many investors putting money into the bond market?
Income. Income is one of the best antidotes for volatility and uncertainty. Versus most taxable bonds and global bonds, municipal bonds remain attractive on a relative basis. (See the Bloomberg rates page for a current overview of global rates.) And, do you think that Federal income tax rates are more like to go up rather than down after the election? If so, that is another argument in favor of munis.
GIven the current economic and political environment, boring and predictable muni bonds are likely to continue to attract attention from investors. As we move into fall, the pace of redemptions will moderate–removing some of the demand component, and new issue volume has historically picked up after Labor Day, so yield-starved investors may see some opportunities in the months ahead. Don’t be surprised if inflows continue.
There are 89 business days between August 22 and Friday, December 30. Are you ready to squeeze everything that you need to get done this year into those 89 days?
And let’s face it…the run-up to the election is going to subtract even more days out of your productive time. If you have not organized your objectives and tasks for the balance of the year, time is running out. But don’t despair! The Summer Thinking List is designed to help you identify what you need to focus on. It’s not designed to sell you anything or to help you sell a particular product…it is designed to help you help yourself. But don’t wait! You don’t have much summer left, and the List will be taken down after Labor Day. Advisors can use the investor version to jump-start your client conversations.
- Go to the Summer Thinking List for Advisors or open the PDF version.
- Go to the Summer Thinking List for Investors or open the PDF version.
The Wisdom of Buffett
By most reports, it has been pretty quiet in the muni market…and, with two more complete weeks until Labor Day weekend signals the unofficial end of summer, trading activity is not likely to pick up much. But as soon as Labor Day is over, it will be off to the races. To help you get ready for the fall sprint, here is this week’s quote from The Poet:
First time I ran
Was to the end of the block
I didn’t know then
That it never would stop
Now I look around
And what do I see
More and more people
Running faster then me
Everybody’s on the run
Everybody’s on the Run, by Jimmy Buffett, from Last Mango in Paris.
THE BOTTOM LINE
Don’t try to time the market! You cannot time the market. If you have money to put to work, be prepared to put it to work. What does your investment policy statement call for? (What? You don’t have an IPS? You need to have an IPS to reduce the influence of emotion on your decisions to buy, sell or hold. Contact me if you need resources to write an IPS.) If you can’t find exactly what you want or need, using a muni ETF can be a good placeholder to maintain your asset allocation until you find the right bonds. See my Bibliography for links to articles about mixing ETFs into your bond portfolio, and for my guide to selecting muni ETFs.
Check Your Call Risk: Rates could go down, and getting bonds called away to reinvest at future lower rates can add lifestyle risk to those living off of their interest income. If you hold premium bonds (and who doesn’t?), beware of how concentrated your call risk is–especially before you add any additional callable bonds to your portfolio.
Beware the Coupon: All other things being equal, lower coupons mean higher duration and therefore higher interest rate sensitivity. Add in the unfavorable tax treatment of market discount on munis and investors who do not plan on holding bonds to maturity should be wary of buying par or discount bonds.
Don’t Forget Taxable Munis! Investors who do not need the tax exempt feature of munis should compare the yields on taxable muni bond offerings versus comparably rated corporate bonds.
Curve Positioning: Don’t pick a spot on the curve because of the yield, pick it because it adds the right risks to your portfolio. Pay attention to the duration (not just the maturity) whether you are looking at a bond, a fund or an ETF. Read this article if you need a refresher on Duration.
Credit Positioning: If the economy improves, rates would be expected to move higher and credit spreads would be expected to tighten. At the right price, taking on some credit risk might be ok, but it makes sense to favor the more liquid parts of the muni market, which generally means single-A rated or better. If you are tempted by the yields and returns in non-investment grade munis, exposure should be for only a minor portion of the fixed income allocation and should be professionally managed and broadly diversified.
What Are Your Concerns?
If you ever have a question or a concern about the muni market and feel that it would be helpful for me to get involved, please do not hesitate to use me as a resource.
Have a great week, and thanks for reading,