My View From The Eighth Month
- Tuesday, 08/19/2014
I begin this commentary with the fundamentals. Performance for municipal bonds since the start of 2014 has been strong thus far. Year-to-date (YTD), municipals have returned 6.18% as measured by the Barclays Municipal Bond Index and 8.20% for the Barclays High Yield Municipal Bond Index. In my opinion, the broad muni market has demonstrated resiliency, with the exception of June, when supply was strong and selling of tobacco and Puerto Rico bonds depressed the market. So far this year, municipal high-yield bonds appear to have continued to deliver potential value, posting comparable yields to corporate high-yield bonds, with yield ratios in excess of 119% on July 31, as illustrated below. This data point could be driving the "crossover trade" from taxable high yield to municipal high yield. As we move through the eighth month of the year, the thirty-day visible supply of $8.1 billion in new bonds1 may potentially fail to cover the demand that could be generated by $41.8 billion of coupons, calls, and maturities flowing into client accounts through August2.
Ratio of Barclays High Yield Municipal Bond Index
to the Barclays Corporate High Yield Index Yield to Worst3
Source: Barclays Research as of 7/31/14.
There is some positive news on the municipal credit side. Moody's reported on July 29 that they upgraded more debt than they downgraded for the first time in six years. Significantly, New York and California earned upgrades to Aa1 and Aa34, respectively. These states are the two largest issuers of municipal bonds.
Finally, the faltering economic fortune of Puerto Rico continues to make headlines, sometimes in dramatic form. With the enactment of the Puerto Rico Public Corporation Debt Enforcement and Recovery Act, which allows certain government owned entities to restructure their debt, the clock is ticking down to a moment when various market participants may be anticipating some action. As much as the selling of certain credits has created an air of desperation, liquidity is seemingly present, and according to SIFMA data, billions of dollars in bonds have changed hands in the secondary market through the end of July. What is even more significant to me, however, is that the broad municipal bond market has been far less affected than one might have expected. The positive returns that the Barclays muni benchmark indices posted in July might suggest the market has moved beyond the headlines.
The Barclays Municipal Bond Index covers investment-grade municipal bonds with a nominal maturity of one or more years. The Barclays High Yield Municipal Bond Index covers below investment-grade municipal bonds with a nominal maturity of one or more years. The Barclays Corporate High Yield Index covers 50 of the most liquid and tradable U.S. dollar-denominated, non-investment grade corporate bonds for sale in the U.S.
1Source: Bond Buyer as of 8/7/14. The 30-day visible supply is compiled daily from The Bond Buyer's Competitive and Negotiated Bond Offerings calendars. It reflects the dollar volume of bonds expected to reach the market in the next 30 days. Issues maturing in 13 months or more are included.
2The coupons, calls, and maturities data was provided by Siebert Brandford Shank and Co., LLC.
3Yield to worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
4Gradations of creditworthiness are indicated by rating symbols, with each symbol representing a group in which the credit characteristics are broadly the same. There are nine symbols that are used by Moody's to designate least credit risk to that denoting greatest credit risk: Aaa, Aa, A, Baa, Ba, B, Caa, Ca, and C. Moody's appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. Ratings from Ba1 to Caa3 are below investment grade or speculative grade.
All of the Market Vectors municipal bond ETFs can potentially hold debt issued by the Commonwealth of Puerto Rico. At the time of this posting, only the Market Vectors High-Yield Municipal Index ETF and the Market Vectors Short High-Yield Municipal Index ETF held Puerto Rico debt. (Click the preceding hyperlinks to view geographic weightings.) This means the Funds would be susceptible to additional risks associated with investment in Puerto Rico.