Colby is Portfolio Manager/Municipal Bond ETFs with more than 30 years of fixed income experience.
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Near-Term Outlook and Performance DriversWhile inflows have been positive, cash for reinvestment, a huge contributor to demand in 2012, has ebbed significantly this March, and is expected to do so again in April. I expect demand will not drive the market forward these next two months as it did most of last year. Looking back at historical returns, since 1990, there have been only five times when March performance has been positive. Large issuance of new bonds, such as the current $2.1 billion California general obligation (GO) issue, is an example of how supply now, and in prior years, has subdued demand. Therefore, my expectations are for munis to underperform slightly these next two months, but create attractive price points for investors come May.Impact of Sequestration on the MarketSince December and the fiscal cliff issue, the municipal marketplace has responded very positively — at least for the first two months — to congressional pronouncements concerning the long-term viability of the tax-exempt coupon. Going forward, however, uncertainty remains as to whether or not Congress will continue to think about, if not impose, limitations on the tax-exempt coupon. One positive note out of these recent events is the fact that the highest personal income tax rate has gone up to 39.6%. This continues to bode well for munis in an absolute sense, because the value of the tax-exempt coupon to those in the highest tax bracket remains significant.Considerations in Light of the Great RotationDespite the terrific performance that the equity markets have put in year-to-date, there are still opportunities to be had for municipal investors. There are two things to be mindful of. First, the Federal Reserve has given no indication yet that rates are about to rise, or about to rise anytime in the near future. So opportunities to earn taxable-equivalent returns from municipal products still look attractive. Second, the municipal yield curve remains steeply-sloped, particularly in the intermediate part of the curve. That's where many professionals suggest that there are, and will remain, opportunities for investors to earn performance returns for the 2013 calendar year.
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Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.
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