Income Investor Perspectives

Independent municipal bond market insights for advisors

Tag: bond investing

Muni Catchup 8/1

Screen Shot 2016-07-11 at 8.44.33 AMTHIS WEEK IN THE MUNI CATCHUP:

  • Overview
  • $30 Billion
  • College Football Playoffs!
  • The Bottom Line
  • The Wisdom of Buffett

Overview

Wow, did I make myself look smart! Out of the 206 municipal market indices published by S&P, 9 of the top 10 total returns for July were reported for taxable indices. Astute readers will recall that I have been reminding muni investors of the benefits of taxable munis, see the Catchups from 7/25 or 7/18 to confirm that. Although, to be honest, I’ll admit that my suggestions were not meant as a market call but as reminders that munis aren’t just for taxable accounts!

The top ranked S&P muni index for the month was the S&P Municipal Bond Defaulted Multifamily Index, but that is so far out of the usual area of interest for most muni investors that I won’t dwell on it here other than to remind readers that accessing that part of the muni market is best left to full-time professional management, so if you are inclined to defaulted or speculative grade munis, do it through a mutual fund or an ETF.

Screen Shot 2016-07-30 at 2.46.49 PM

Sorry…I didn’t mean to make the table into an eye test! Click here to open ito open it as a PDF.

Even with the soft total return performance for the muni market for July, the Year to Date and Trailing 12-Month total returns for most muni indices have numbers more like equity returns. See the Context page for more total return index data. Another example of my view that “Low Yields ≠ Low Return.”

As you’ll notice from the Yield Trend Table on the Context page, muni yields finished the month slightly higher, while Treasury yields ended noticeably lower. The news flow for the month pushed Treasuries around a lot…the political conventions, the FOMC meeting and the GDP report to name just a few influences.

The last table on the Context page is the recent recap of flows into muni bond mutual funds and ETFs, which have benefitted no doubt from the heavy flow of matured and called bonds in June and July (and probably will in August too), yet it is remarkable that the YTD inflows are well ahead of the last two calendar year totals. In my view, this is a result (at least in part) of investors needing to replace their earned income with portfolio income. Don’t be surprised if a jump up in yields–if it ever happens–also results in an additional bump-up in inflows to the muni market from yield-hungry investors.

$30 Billion

Yup…there will be an estimated $30 billion in munis redeemed in August. But you knew that already, didn’t you? All of that money will have to go somewhere. Some of it may not get re-invested until clients and advisors are back from the beach or the lake, but chances are a good chuck of it will stay in munis–either in bonds, funds or ETFs, likely providing some good buy-side interest.

College Football Playoffs!

There are only 106 business days left until the College Football Playoffs begin on New year’s Eve in the Peach Bowl. That’s not a lot of time…my recommendation is to procrastinate later, and get to work right now planning out the rest of the year to be sure you squeeze as much out of it as you can. There are only a few weeks left for you to print out your version of The Summer Thinking List–there’s one for advisors, and a short version for clients and prospects. This year’s lists are my all-time most viewed post. Do your self (and your clients) a favor and put them to use!

The Bottom Line

Check Your Calls: Premium are at an increased risk of being called away–this doesn’t mean that you should sell callable bond holdings, but it does mean that you should only add additional callable premium bonds after evaluating the concentration of call risk in your portfolio. It would also be sensible to evaluate what you would do if your callable bonds were called at their next call date.

Beware the Coupon: Favoring par bonds now may not be a prudent move for investors because of the potential exposure to the unfavorable tax treatment on market discount should rates move higher. If you are a buyer, continue to favor premium bonds–to reduce the risk of bonds moving to a discount if rates move higher.

Pay Attention to Duration, but Don’t Be Afraid of It: It may be tempting to put new money to work where performance has been the strongest (in long-duration bonds, funds or ETFs), but we all know that past performance is not an indicator of future returns. When the market turns, duration will be the total return investor’s foe. Unless you are an active total-return investor prepared to react quickly to market changes, new money should be put to work in line with the long-term goals as defined by your investment policy statement. But don’t be afraid of duration…it is possible to be too short on the yield curve. As can be seen in the yield curve on the Context page, there is a bump in the muni yield around the 15-year spot on the curve–going beyond that spot produces less incremental return for taking on the additional duration.

And still, Don’t Forget Taxable Munis! Investors with money in tax-deferred or other non-taxable accounts should compare the yields on taxable muni bond offerings versus comparably rated corporate bonds.

The Wisdom of Buffett

The dog days of summer are here…what are you going to do with them? Let’s see what we have this week from The Poet:

 

You need a holiday
take a holiday
find a far off wonderland
where you might regain command
of your life today

Take a holiday
you need a holiday
grab a pack and hit the trail
take a sail
and wind up in some moonlight bay

You’re caught up in the Internet
you think it’s such a great asset
but you’re wrong, wrong, wrong
All that fiber optic gear
still cannot take away the fear
like an island song

From Holiday, by Jimmy Buffett

It’s time for me to take a little holiday…no Catchup next week. See you on August 15!

Thanks for reading,

Pat

 

IMG_5515This is not investment advice. The opinions expressed and the information contained herein are based on sources believed to be reliable, but accuracy or appropriateness is not guaranteed. Past performance is interesting but is not a guarantee of future results. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Indices are not available for direct investment, although in some cases, there may be ETFs available designed to track some of the indices shown. The author does not provide investment, tax, legal or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Additional information available upon request.
©2016 Patrick F. Luby
All Rights Reserved

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Muni Catchup 6/6

Welcome to Pat Luby’s Muni Catchup for June 6, 2016.

IMG_5515Context

Wow! What a difference a day makes! With the weak unemployment report on Friday, market consensus appears to be that a June rate hike by the Fed is not likely. (Click here to read Bloomberg’s analysis.)

Bond yields reacted by dropping–a lot! In the 5-year spot, muni yields declined by 2 Basis Points (100 Basis Points equals 1 percent), while U.S. Treasuries dropped by 13 BPs. In 10-years, the decline was 2 BPs for munis and 10 for USTs. Thirty yield yields also moved lower, by 5 BPs for munis and 6 for USTs. It is not surprising that the largest moves were in the short-to-intermediate parts of the curve, since historically, changes in monetary policy have had greater influence on the shorter end of the yield curve, while the long end of the curve tends to react more to changes in inflation expectations.

Investors often draw an artificial line in the sand at 10-years, and will not extend into maturities beyond that spot on the curve. As a result, there can be an over-concentration of demand that gets crowded into the 10-year maturity, creating an extra bump-up in yield for going slightly longer than 10-years. Right now, the inflection point–where incremental yield tapers off–can be seen in the 15-to-17 year range. ( See the Yield Comparison graph on the Context page.)

Extending beyond that point offers less incremental yield for taking on the additional Duration risk. As a general guide, it is helpful to pay attention to what percentage of the yield curve is captured by specific spots on the curve. Right now, it looks like this:

60% 14-years
70% 16-years
80% 19-years
90% 22-years

This doesn’t mean you should focus on one of these spots, but it can be a helpful point to keep in mind as you balance risk and return.

The further out you go on the curve, the cheaper that munis become relative to U.S. Treasuries, so it would not be surprising to see some increased muni buying from crossover buyers or non-U.S. fixed income investors.

Investors who have had principal returned from June 1 redemptions may be feeling anxious with the decline in yields–if the right bonds are not immediately available, it may make sense to maintain your exposure to the investment class by using muni bond ETFs. If you haven’t used muni ETFs, read about How to Pick the Right Muni Bond ETF and also Duration as a Guide With Muni ETFs so that you can maintain a similar risk exposure.

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The next regular Muni Catchup is scheduled for Monday, June 13, but there are a couple of specials planned over the next two weeks, so if you are not already subscribed, be sure to sign up to be notified by email when new items get published.

If you find this to be helpful, please let me know. You can help me by circulating this and encouraging others to enjoy the Muni Catchup and IncomeInvestorPerspectives.com

Your comments and questions are welcome and appreciated.

Thanks for reading,

Pat

Screen Shot 2016-05-30 at 10.00.13 AMThe opinions expressed and the information contained herein are based on sources believed to be reliable, but accuracy or appropriateness is not guaranteed. Past performance is interesting but is not a guarantee of future results. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Indices are not available for direct investment, although in some cases, there may be ETFs available designed to track some of the indices shown. The author does not provide investment, tax, legal or accounting advice–this is NOT investment advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Additional information available upon request.

 

Are you smarter than an FOMC’er?

Short-term interest rates are influenced first and foremost by monetary policy. So if you want to know where rates are going–and when–you would want to know what the members of the FOMC are thinking. Right? They’re in the driver’s seat, with their collective foot on the gas pedal or the brake. Hence, pundits, strategists, portfolio managers and traders all carefully tear apart the FOMC pronouncements, going so far as discussing the meaning of changes in punctuation.

Most individual investors, though, are less interested in immediate trading insights as they are on the trend. Having waited for so long for rates to go up to more attractive levels, investors want to know when they should re-allocate to bonds. So let’s look at what the FOMC members think about rates. Below is the latest “FOMC Dot Plot,” released June 17:

FOMC dot plot 6-17-15

Even the members of the FOMC are not of one opinion. At the end of this year, opinions for the Fed Funds target rate are clustered between .125% (2 members) to .875% (5 members). But for the end of 2016, the opinions are in a wide range–from .375% (1 vote) to 2.875% (2 votes).

Which opinion is correct? Are any of them correct? There are so many variables at work, forecasting rates with precision is not realistic. Even Alan Greenspan tried to to discourage interest rate forecasting when he was answering questions from members of the House Committee on Financial Services,

I think forecasting markets is very difficult, I would argue at the end of the day, probably with rare exceptions, almost impossible. But what you can do is measure the risks. And the risks essentially are different from somebody who is 30 years old and is saving for retirement or one who is 55. And I think those types of judgments are crucial and important for appropriate investment policies for retirement, and I don’t think you can generalize very far down the road. (Alan Greenspan, speaking as Chairman of the Federal Reserve, April 30, 2003.)

Yet waiting for higher rates remains very popular. However, by trying to time rates and underallocating to bonds, investors may unwittingly be taking on more risk by missing out on the diversification benefits of holding bonds with their stocks. We believe it is unwise to try to time interest rates, and suggest instead to mitigate the risks of a rising rate environment by adjusting within fixed income (which specific investments you own), rather than shifting your asset allocation. Click here to read more about timing rates.

Bottom line: unless you are smarter than an FOMC’er, let your investment policy determine your asset allocation. Your view of market conditions and trends should influence which investments you select–not whether or not you remain invested.

 

 

This is an update of my earlier post dated May 26, 2015. The source for the Dot Plot is available at the FOMC website.

The information contained herein is based on sources believed to be reliable, but its accuracy is not guaranteed. Past performance is interesting but is not a guarantee of future results. The author does not provide investment, tax, legal or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Additional information available upon request.

©2015 Patrick F. Luby

All Rights Reserved.

BONDS ARE NOT STOCKS

What equity investors should know about bond investing

  • Bonds are Not Stocks;
  • Ratings, Credit Risk and Political Risk
  • Dividends and Interest;
  • Low Rates Don’t Have to Mean Low Return;
  • Liquidity Risk
  • Bonds or Bond Funds
  • How About Bond ETFs?
  • Interest Rate Risk
  • How Will ____ Affect My Bonds?

An old bond trader’s maxim says that you make you money when you buy—not when you sell. Selecting bonds or a bond manager uses many of the same business decision making processes as are used in the equity portfolio, but because of the different characteristics of the two classes of assets, investors need to bring a different perspective to how they recognize and manage risks.

To read the article, please click here.

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