High Flying Municipals

I continue to find worthwhile municipal bonds for clients despite the historically expensive pricing of generic municipal bonds. While treasury securities are at their highest yields (and lowest prices) in over five months, municipal bonds continue their relative pricing superiority.

Packages of municipal bonds, such as mutual funds and exchange traded funds (ETF’s), are priced high relative to their historical averages to treasury securities. Such high prices have helped their performance relative to other fixed income securities.

Today, the ten-year AAA municipal yield of 2.74% is but 59% of the 4.64% of the ten-year treasury note (all yields and prices per Bloomberg). As we have talked about recently, if such spread was even 70% (much less of a historical outlier), municipal yields would need to rise about fifty basis points to 3.25%. Lower actual yields mean municipal bond prices are priced higher, thus contributing to positive performance of late.

This current situation has contributed to the Bloomberg Municipal Bond Index outperforming not only the Bloomberg Treasury Index, but also Bloomberg’s Aggregate Taxable Bond Index which includes corporate bonds and mortgages as well as treasuries. This outperformance runs across a one-year time horizon (+3.12% vs -1.50% vs -0.24%) but also five years as well (+1.59% vs -1.84% vs -.23%).  Those are annualized figures, and they should be depressing for almost all owners of bonds, yet somehow municipal investors are hanging on to hope that their positive returns do not turn negative like all other bonds. This week Bloomberg’s Municipal Bond Index showed the following annualized returns: 3.12% for one year, 1.68% for two, -0.41% for three and 1.59% for five years.

Municipal bonds, like other spread products, such as corporate bonds and mortgage securities, usually play the role of tail to the treasury market’s dog. The dog wags its tail, not the other way around. While extremes do happen in financial markets, our current situation should be a clear signal that municipal bonds are a market and are subject to extremes in valuation, here certainly on the upside.

Back to the dog, treasury security prices continue to weaken, indicating a quicker end to the bond market correction of the past six months. Treasury bill yields are now only fractionally below their highs of last summer while the two-year treasury note hovers near 5% and the ten-year treasury note is closing in on 4.75%. These levels need to be held to postpone the next leg down in bond prices. The correction appears to be holding on by a thread.

If all bonds performed alike, bond investors might be particularly worried. But we have been here before. In 2020 when I declared the bond bull market over, we lived through the worst treasury bond market performance ever. Not just bad, but worse.

Municipal bonds performed poorly as well, though not the complete debacle of treasuries. While such “not as bad as treasuries” may be somewhat comforting, our reality here at The Select Approach^TM, performance-wise, has been quite different.

Your portfolio was built for a market turnaround like we have seen. Your reality has not been the reality of the treasury market performance or even the municipal bond experience indicative in Bloomberg’s indexes. The reason is selection; The Select Approach^TM.

I built my career in the municipal bond market because it is unique. Tens of thousands of different bonds, all with unique qualities, terms, and conditions. Your portfolio is unique and one way it is unique is that it does not scale.

Scale is largely, in my opinion, why financial markets trade at the levels they do today. That NVIDIA (NVDA) can trade at a $2 trillion market capitalization earlier this year (while the municipal market totals only a measly $4 trillion) is due to scale. The newest thing, AI (artificial intelligence), seemingly came out of nowhere and scaled up companies’ stock prices like NVIDIA due to its scalability.

Billion-dollar stock buybacks? No problem with scalability. Wall Street can sell billions in corporate bonds to buy billions in stocks all day long.

Do not get me wrong. There is scalability in municipal bonds…on Wall Street’s side. Wall Street can put your millions and billions to work in the municipal bond market quickly and efficiently they will tell you. But if you invest in scale, you must be prepared for the performance scale brings with it. For those bond investors, this means betting on a continuation of the bull market in bonds.

Simply, bonds are fixed income. In a bull market, bonds possess the leverage to provide double digit returns for many years. Scaling up in a bull market is a wonder to behold; not knowing the trend has changed…quite the opposite.

Needville Independent School District, TX

Unlimited Tax School Building Bonds, Series 2024

Aa2 Moody’s Under AA- Fitch Under

Aaa/NR/AAA on Permanent School Fund

Due 8/15   Dated 5/1/24 Maturity 8/15/54

$68,640,000 Sold

Years   Maturity       Coupon        Yield*

4         2028             5.00%           3.01%

5         2029             5.00%           2.99%

6         2030             5.00%           2.98%

7         2031             5.00%           2.96%

8         2032             5.00%          2.98%

9         2033             5.00%          3.00%

10       2034             5.00%          3.02%

11       2035**          5.00%          3.11%

12       2036**          5.00%          3.18%

13       2037**          5.00%          3.30%

14       2038**          5.00%          3.36%

15       2039**          5.00%          3.44%

16       2040**          5.00%          3.55%

17       2041**          5.00%          3.67%

18       2042**          5.00%          3.73%

19      2043**           5.00%          3.79%

20      2044**           5.00%          3.85%

25      2049**           4.00%          4.30%

30      2054**           4.00%          4.35%

*Yield to Worst (Call or Maturity) **Callable 8/15/34

Source: Bloomberg

This is an example of a new issue priced the week of 4/22/24

Prices, yields and availability subject to change