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I believe that 2013 promises to stand in contrast to the linear upward moves for municipal bonds in 2012. There appears to be conflicting expectations about new issue supply, so my conservative view is to say that volume has the potential to be +/- 10% of that of 2012. Much depends on a solution out of Washington concerning taxes, entitlements and federal support for state and local government programs.My outlook anticipates that municipal bond tax exemption should remain in place for individual investors and allow municipalities continued access to the capital markets, as has been customary since the early 20th century. The uncertainty includes a possible return to stimulus, such as the Build America Bond program.Even if some of the tax benefit was capped at 28%, the muni market already seems to be anticipating higher nominal rates in the second half of 2013, and an adjustment could happen very suddenly if new legislation regarding muni tax exemption is passed.2012 was more profitable for muni investors than was predicted at the beginning of the year. Year-to-date index returns of 8.12% for the Barclays Municipal Bond Index and 18.11% for the Barclays Municipal High Yield Index summarize a story that includes spread narrowing, curve flattening and large inflows to municipal funds (nearly $50 billion YTD). Though there were more credit downgrades than upgrades, I believe 2012 will deliver fewer defaults or credit impairments than the prior two years.Overall, I believe municipals will continue to offer investors potential opportunity in terms of yield and return in 2013. However, there may be less of a total return opportunity than we've seen in 2012, since quality spreads have narrowed throughout 2012 and the curve could flatten in a meaningful way in the 1–10 year segment.
Source: FactSet. For illustrative purposes only based on historical performance of various indexes. Please see index descriptions below. The listed indices are unmanaged and are not securities in which an investment can be made. Historical information is not indicative of future results. Past performance is no guarantee of future results. Not intended to be, nor should it be construed or used as investment, tax or legal advice, any recommendation, or an offer to sell, or a solicitation of any offer to buy, an interest in any security.Index DescriptionsUS AGG: Barclays US Aggregate Index is composed of intermediate-term government bonds, investment-grade corporate debt securities, and mortgage-backed securities. US HY CORP: Barclays US Aggregate Credit Corporate High Yield Index is composed of fixed-rate, publicly issued, non-investment grade U.S. corporate debt. GLB HY CORP: BofA Merrill Lynch Global High Yield Index is composed of USD, CAD, GBP and EUR denominated below investment grade corporate debt issued by corporations from developed and emerging markets countries. EM USD CORP: BofA Merrill Lynch Emerging Markets Liquid Corporate Plus Index is composed of USD denominated investment-grade and non-investment grade debt issued by corporations in emerging markets countries. EM LOCAL SOV: JP Morgan GBI-EM Global Composite Index is composed of local currency denominated non-investment grade debt issued by emerging markets governments. EM USD SOV: JP Morgan EMBI+ Index is comprised of USD denominated debt issued by emerging markets governments. US CORPS: Barclays US Aggregate Credit Corporate Investment Grade Index is the investment grade corporate component of the Barclays Capital Global Aggregate Bond Index. MORTG REIT: Barclays US Aggregate Mortgage Index is the U.S. MBS component of the Barclays U.S. Aggregate index. GLB AGG: Barclays Global Aggregate Index is composed of the U.S. Aggregate, Pan-European Aggregate, and the Asian-Pacific Aggregate Indexes. It also includes a wide range of standard and customized sub-indices by liquidity constraint, sector, quality and maturity. TIPS: Barclays US Aggregate Government TIPS Index is composed of TIPS with one or more years remaining maturity with total outstanding issue size of $500m or more. MUNI: Barclays Municipal Bond Index is composed of tax exempt revenue bonds and state government obligations. HY MUNI: Barclays Municipal High Yield Index is the below investment grade subset of the Barclays Municipal Bond Index. US TREAS: BofA Merrill Lynch US Treasury Index of US dollar denominated sovereign debt publicly issued by the US government in its domestic market. PREFERRED: BofA Merrill Lynch Core Fixed Rate Preferred Securities Index is composed of fixed rate U.S. dollar denominated preferred securities issued in the U.S. domestic market.
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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.
The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.
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