Finding Relative Value in the Municipal Market
Contagion risk is gripping society and financial markets alike. Year-to-date the S&P 500 is down nearly 15% while oil dropped 25% yesterday alone. Treasury bond yields have dropped precipitously and at one point every rung of the Treasury yield curve traded at a yield below 1%. The Fed attempted to provide reassurance on March 3rd by implementing a 50 basis points (0.50%) emergency rate cut (from 1.75% to 1.25%) – the first since the crisis in 2008. And the VIX Index, a measure of the 30-day expected volatility of the U.S. stock market, is up over 208% since February 20th. Some now worry that these market conditions themselves are enough to induce a recession, let alone the coronavirus’s unknown toll on consumer spending.
We too are not taking the potential implications from the coronavirus outbreak lightly (both at an individual health and financial market level). Although this type of market is unwelcome, it serves as a good reminder of why any high-net-worth and conservative investor should own high-grade municipal bonds.
Muni’s are what we thought they were! (see Dennis Green)
Broadly speaking, the municipal market has rallied (higher prices/lower yields) concurrently with Treasuries. The 10-year, AAA-rated municipal benchmark yields 0.78%. It started the year at 1.44%. Therefore, municipal bonds have served their intended purpose as a portfolio ballast during uncertain and volatile times.
Furthermore, our separate account portfolio approach (vs. mutual funds) provides investors another level of protection through direct ownership and customization of holdings. Given the volatile nature of these markets, any forced selling or buying within a mutual fund (induced by outside investors within the fund), is likely not advantageous for the individual investor. A separate account structure benefits in these situations.
| Tenor | Treasury %* | Open MMD** | Muni/ Treasury Ratio |
| 2YR | 0.43 | 0.45 | 105% |
| 5YR | 0.54 | 0.49 | 91% |
| 7YR | 0.64 | 0.61 | 95% |
| 10YR | 0.65 | 0.78 | 120% |
| 30YR | 1.09 | 1.38 | 127% |
*Taxable Treasury rates on 3/10/2020 @ 9:45 AM.
**Tax-Free Municipal Market Data average yields on 3/10/2020.
Value still to be had
The municipal market on a relative basis is ‘cheap’ compared to other high-grade fixed income alternatives. The 10-year taxable treasury yield closed yesterday at 0.57%, while the 10-Year, AAA rated tax-free municipal is paying 0.78%, or a taxable equivalent of 1.24% at the highest federal tax bracket. The tax-free municipal yield is 137% of Treasuries, even before the tax benefit is considered.
Now certainly is a good opportunity to find relative value within the municipal market.
As always, we are here to discuss any questions you have about your portfolio or the market. Please reach out to your Investment Specialist or Portfolio Manager.
~Tom Bernardi, CFA – Portfolio Manager