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No Lake Wobegon for Munis? - Friday, 05/03/2013

"Lake Wobegon, where all the women are strong, all the men are good looking, and all the children are above average." – Garrison Keillor

Shall we compare the municipal market to the fictional Lake Wobegon? This asset class continues, in my view, to exhibit solid, stable characteristics that I believe make it nearly impervious to the exogenous volatilities of the world around it. The Barclays Municipal Bond Index is still AA31 average quality, tax collections for states are predicted by many analysts to exceed pre-recession levels and, according to Bloomberg, the economic health of 44 states improved in the fourth quarter of 2012. As the recovery continues to gain ground, I believe strong, good looking and above average could apply to the municipal bond market.

All things considered, if one were to judge the municipal bond market by performance alone (-0.43% in March and 1.10% in April2), the past two months have been rather indifferent. Behind the numbers, however, the market has been churned by a handful of significantly large (+$1 billion) new deals, a steady outflow of cash from bond funds and the well documented political assault underlying the Obama administration’s proposed budget, which, if passed, would cap the tax-exempt benefit at 28%. And despite the obvious flaws reflected in names such as Harrisburg, Vallejo, Stockton and Detroit, in my opinion, this asset class, if nothing else, demonstrated its resiliency. (See timeline graphic.)



Municipal AAA GO 10-Year Yield Chart

I believe the near-term outlook for municipals continues to build a positive narrative, as investible cash from maturities, bond calls and coupon payments should, in my opinion, prime demand. Now that we have personal income tax payments in our rear-view mirror, investors can again focus on the fundamentals which I believe continue to argue for municipals as a positive income generator with generally high credit quality and potentially less volatility than some other fixed-income options. Lake Wobegon doesn’t sound so bad after all.

1Source: Moody’s. The Moody’s rating scale is as follows, from excellent (high grade) to poor (including default): Aaa to C, with intermediate ratings offered at each level between Aa and Ca. Anything lower than a Baa rating is considered a non-investment-grade or high-yield bond.

2Source: Barclays. Based on the Barclays Municipal Bond Index which is considered representative of the broad market for investment-grade, tax-exempt bonds with a maturity of at least one year.


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