Munis and Treasuries Go Their Own Way
with Tom Dalpiaz, Managing Director (December 2, 2014)
Long-time municipal bond market observers often describe the behavior of munis by saying that they generally follow the lead of Treasuries though not necessarily to the same degree. For many time periods, that’s a fair description. Still, there are times when that familiar refrain simply doesn’t fit. November was one of those times as muni and Treasury bond yields moved in generally disconnected ways. Intermediate muni bond yields spent most of November marching steadily upward and then falling slightly in the last week or so of the month. In the same period, ten-year Treasury bond yields moved in a saw-tooth, range-bound pattern until they fell sharply toward the end of the month. These divergent paths have created attractive Muni/Treasury ratios not seen since April.
Additional muni bond supply was the main culprit driving muni yields higher last month. This seasonal effect was not unexpected. In addition to the actual increase in new muni deals that came to market, muni market participants may have been partially reacting to the notion of increased new issue supply in the near future as well. Election results showed a sizable increase in the volume of new bond issues on the ballot, a high percentage of which were approved by voters. It remains to be seen just when those new bond deals will come to market, but forward-looking markets often make pre-emptive adjustments based on future worries. Perhaps some of that occurred last month in the muni market.
Treasury bond yields throughout November were moved primarily by overseas influences including indications of a Japanese recession, rate cuts by the Chinese Central Bank, and falling oil prices. The difference between the two markets last month can be reflected in total returns: ten year Treasuries were up 1.42% while the Barclays Ten Year Muni Bond Index was up just 0.17%.
Taken together, the different paths of munis and Treasuries last month serve as a reminder against slipping into the habit of broad-brush characterizations of the bond market as a monolithic entity. Broad statements such as “Interest rates are going up and the bond market is in for trouble” should prompt responses such as “What interest rates are you talking about? What particular part of what bond sector are you referring to?” We suggest bond investors can garner greater insight when the wide diversity of the bond market is recognized and sector-specific influences and structures that move particular bonds are understood.
Municipal bonds have had an impressive year-to-date ride even with a November not worth boasting about. The 7-year and 10-year Barclays Municipal Bond Indices have returned approximately 6% and 8.2%, respectively, so far in 2014. Longer maturities have performed even better. The prospect of future muni bond total returns not matching 2014’s impressive results should not distract bond investors from the attractive relative income that can be currently captured from munis. For investors in the top Federal income tax brackets, taxable-equivalent yields of 4% to 4.4% currently garnered from a portfolio of investment grade, intermediate maturity munis remain attractive in a world of 2.27% ten year Treasury yields. We continue to see value in selected single A rated, above-average coupon, callable muni bonds in the five to seven year and ten to twelve year ranges.
Munis By The Numbers
(Sources: Bloomberg, Barclays Capital)
When does 2.41%=4.26%? When you are an individual investor subject to the top Federal income tax brackets and you capture a 2.41% yield from tax-exempt municipal bonds.
The 2.41% yield stated above is our conservative estimate of an average yield to maturity for a muni bond portfolio constructed under present market conditions with the following parameters: all investment grade credits, average credit rating A1/A+, all bonds mature within 15 years, average maturity 5 to 6 years, portfolio duration range 3.5 to 4.5 years.
10-year High Grade Muni bond yields as a percentage of 10-year Treasury bond yields: 103%(compared to an average ratio of 98% for the past ten years).
10-year Single A rated Muni bond yields as a percentage of 10-year Treasury bond yields: 158%(compared to an average ratio of 126% for the past ten years).
Moving from cash to 5-year munis: +127 basis points (Yield difference on tax-exempt money market funds and AA rated tax-exempt muni bonds with a 5 year maturity).
Moving from 2-year munis to 10-year munis: +229 basis points (Yield difference on AA rated 2-year tax-exempt muni bonds and AA rated 10-year tax-exempt municipal bonds. Average spread for the past five years is 224 basis points).
+0.06% November total return of the Barclays 3-Year Municipal Bond Index (+1.51% YTD, +1.33% for all of 2013)
+0.06% November total return of the Barclays 5-Year Municipal Bond Index (+3.52% YTD, +0.81% for all of 2013)
+0.07% November total return of the Barclays 7-Year Municipal Bond Index (+5.99% YTD, -0.97% for all of 2013)
+0.17% November total return of the Barclays 10-Year Municipal Bond Index (+8.21% YTD, -2.17% for all of 2013)
+0.34% November total return of the Barclays Long Municipal Bond Index (+14.22% YTD, -6.00% for all of 2013).
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The opinions expressed are those of the Granite Springs Asset Management LLC Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. This material is for educational purposes only. Granite Springs Asset Management LLC is an investment adviser registered with the US Securities and Exchange. Registration does not imply a certain level of skill or training. More information about Granite Springs Asset Management LLC can be found in its Form ADV which is available upon request.