After a difficult month of May, municipal bond investors are now faced with what has historically been a difficult start to June. On a positive note, the start of summer in late June typically ushers in one of the more attractive times of the year to own municipal bonds. Buying demand from maturing bond proceeds combined with a slowdown in new issuance normally creates a more favorable supply-demand dynamic that typically benefits the municipal bond market from late-June through the end of August. June and July represent the two heaviest months in terms of maturing bonds for the municipal bond market and reinvestment demand can be a powerful force. Municipalities typically issue new debt to replace maturing debt, leading to an increase in issuance, and the first two weeks of June can witness weakness as investors assess the market reception and impact of new bond issuance before reinvesting maturing proceeds.
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To put the seasonal pattern in perspective, July, has been the best month for municipal bond investors since 1990 with an average 1.0% return during the month according to Barclay’s Municipal Bond Index data going back to 1990. Furthermore, July has generated positive performance on all but two occasions over that time period. August is not far behind July with an average 0.8% total return and posted positive returns in all but five years – not quite as impressive as July but a good batting average.
Seasonal patterns do not always come to fruition, however. May is typically one of the strongest months for municipal bond performance but May 2013 certainly disappointed. To put it in perspective, municipal bond performance in May was the weakest since December 2012, which witnessed a surge in new bond supply, and in turn is the weakest since late 2010, when Meredith Whitney-related credit quality fears sparked a violent municipal bond sell-off. Such bouts of weakness are rare, and May 2013 selling was is in large part due to taxable bond market weakness in response to Federal Reserve (Fed) quantitative easing ( QE) tapering fears.
We believe bond market fears over Fed QE tapering may be overdone and pushed yields too far too quickly. The Fed is only changing the amount of monthly purchases at this point, its commitment to refrain from raising rates until the unemployment rate falls to 6.5% (a period of time which extend until mid-2015) remains intact, and market expectations appear to have corrected with the consensus among primary dealers shifting to expect QE tapering to begin in September 2013 up from December 2013. In other words, the rise in yields may have already priced in the impact of uncertainty from the Fed.
The recent rise in yields coupled with any additional increase that may come from typical June challenges may result in an opportunity for municipal bond investors. There are still risks that include no guarantee that seasonal strength may manifest itself and a still-heavy amount of bonds lingering in the secondary market, which also played a role in pressuring prices recently. However, average AAA-rated municipal bond yields are already at their highest levels since April 2012 (according to Municipal Market Advisors [MMA] data), a more reliable favorable seasonal period may be just around the corner, municipal-to-Treasury yield ratios are back up to 100%, and signs that selling may have become indiscriminate (as yields on higher creditworthy issues converging with lesser creditworthy bonds) offsets these risks in our view and helps buffer downside for investors.
We believe high-quality intermediate to longer-term maturity bonds suffered the brunt of recent weakness, were inordinately punished, and, in our view, may stand to benefit most from seasonal strength. Both segments possess more attractive valuations relative to short-term bonds and would benefit more from any subsequent decline in yields. Keep in mind that such opportunities should be balanced against what is still a low-return environment for bonds. But in a low-yield world, such pullbacks will likely be few and can provide potential opportunity for investors.
About Anthony Valeri
As Senior Vice President and Market Strategist, Anthony is a member of the Research department’s tactical asset allocation committee and is responsible for developing and articulating fixed income and general market strategy. Anthony regularly communicates market strategy to LPL Financial advisors, contributes to the Research department’s flagship publications, is a speaker at LPL Financial conferences, and authors Bond Market Perspectives, a weekly client commentary on the bond market. Anthony has been quoted in a number of national online and print publications including Bloomberg News, Reuters, and Dow Jones. Prior to joining the Research Department in January 2002, Anthony was Head Trader of the LPL Financial fixed income-trading desk. Anthony has 18 years of investment experience.
Anthony received a BA in Quantitative Economics and Decision Sciences from the University of California at San Diego in 1992 and received his Chartered Financial Analyst designation in September of 1999. Additionally, Anthony is Series 7 and 63 registered. Anthony is a member of both the Association for Investment Management and Research and the Financial Analysts Society of San Diego. Anthony has been with LPL Financial since June 1993.Want to learn how to generate more income from your portfolio so you can live better? Get our free guide to income investing here.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.
Credit quality is one of the principal criteria for judging the investment quality of a bond or bond mutual fund. As the term implies, credit quality informs investors of a bond or bond portfolio’s credit worthiness, or risk of default.
Municipal Market Advisors is an independent municipal market research firm that provides strategic analysis and commentary on the U.S. municipal market.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.
Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
An obligation rated ‘AAA’ has the highest rating assigned by Standard & Poor’s. The obligor’s capacity to meet its financial commitment on the obligation is extremely strong.
The municipal to Treasury ratio compares the current yield of municipal bonds to US Treasuries.
Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
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