Have you noticed the municipal bonds bandwagon is getting crowded now as the punditry sings their praises?
You’ll probably recognize the voices. They’re the same ones who for the past 12 months have warned of an imminent deluge of government failures and a rising interest rate environment.
While their recent revelation – that municipal bonds are particularly advantageous – is correct, their flawed analysis over the past year should once again serve as a warning to bond investors about the dangers of trying to time the market.
Funds vs. individual bonds
Last year, as they indiscriminately skewered the entire municipal bond market, commentators failed to make an important distinction between individual municipal bonds and muni mutual funds, and the particular goals of each.
For fund investors, 2013 was indeed rough. Spooked by media predictions of catastrophe following the financial woes of Detroit and Puerto Rico, investors pulled $58 billion from muni funds and NAVs suffered. The Barclays Muni Bond Index dropped 2.6%.
The story for individual municipal bond investors, however, was different. They control what’s in their portfolio and focus on the predictable stream of tax-free income their bonds generate. They know that bonds held to maturity will be redeemed at 100.00, regardless of the level of interest rates at any given time. Market values along the way are not a concern.
The pundits, however, unfamiliar with these details, provide no context in their analysis.
New story
As it turned out, of course, their headline-making pronouncements, which prompted much of the anxiety, were overblown and misleading, and are an embarrassing lead-in to their new narrative: “Munis are outperforming other fixed-income investments and it’s time to start buying again!”
Well, yes, the market they damaged as a result of their rhetoric is indeed recovering; demand for munis and muni funds is on the upswing. But what initially cowed investors became a crisis largely manufactured by the same people who are touting munis now.
Actually, the more important story gaining traction today with investors is a genuine concern with rising taxes, which requires no hype.
As we pointed out (“Attention Tax-Ladened Investors“), the top federal income-tax rate has jumped from 35% to 39.6% and the new 3.8% tax on investment income has created some astonishing tax-equivalent yields.
For example, tax rates for the highest earners in New York are more than 48%. To equal the 4.50% yield they would receive on a high quality tax-free bond, New Yorkers would have to find a security yielding a taxable equivalent of more than 8.50%. For California’s highest earners, they’d need to find an investment with a taxable equivalent yield of 9.15%.
As it turns out, this newfound enthusiasm in the financial headlines and among the pundits is correct. Problem is, if you followed their advice before, you’d only now be climbing out of the ditch they helped dig.
Municipal bonds aren’t dramatic. They don’t lend themselves to hyperbole or the day-to-day commentary prevalent in the equity markets. For muni investors, the excitement is in the dependable stream of tax-free income.