MainLine West – June 2013 Market Review

MainLine has been advocating that 2013 would bring windows of opportunity.  Currently we have a great opportunity despite it occurring at one of the least likely times of the year from a historical perspective. During the month of June, the municipal market experienced a market sell-off equal only to that which we saw in late 2010.  A combination of adverse forces came together to create the perfect storm.  We highlight this market action and the subsequent opportunity in this month’s market review.  

 The Perfect Storm:

On June 19th Chairman Bernanke whispered the word “taper” and the market reacted. Even before this news, there were other “storm fronts” building in the municipal market horizon.

 1)       The demand side “cold front”: Investors concerned over a cutback in Fed quantitative easing and higher rates had begun shifting away from municipal bond funds in early June. The Lipper/AMG weekly reporting has shown that over $4.5 billion have flowed out of municipal bonds funds since early June.

2)       Supply Side “warm front”: These outflows then prompted forced liquidations by the municipal bond funds into a weakened secondary market. This combined with a building new issuance calendar created an excess of supply that the market had no bid for.

3)       Liquidity “freeze”: Further hurting the ability to sell bonds, broker/dealers became unwilling to take on additional inventory in advance of the 4th of July holiday. They had already built up their inventory in anticipation of the usual favorable summer demand technicals, which were now in reverse.

In the end the result has been a dramatic decline in municipal bond prices. Since the beginning of the month, and at its worst, MMD triple-A yields jumped 89 and 73 basis points, in 30 and 10 year maturities. In recent days yields have bounced back quickly at roughly 30 bps. Yet the new level of rates has created an investment opportunity as we are still at relatively attractive levels versus taxable bonds, and historical averages.

 A Window of Opportunity:

MainLine feels the worst yield corrections could be behind us for municipal bonds in 2013. We feel that values should stabilize a bit going forward, and feel this is a good entry point for investors looking to put money to work. Below are some examples of the value prevalent in the market today:

5-year maturity essential service revenue bond:

1.75% to 2.00%

10-year maturity essential service revenue bond:

3.25% to 3.50%

15-year maturity essential service revenue bond: 

4.00% to 4.20%

20-year maturity essential service revenue bond:

4.50% to 4.75%

 By year end, MainLine feels the fundamentals are still in place for municipal bonds to perform well versus other fixed income investments. This confidence comes from the following:

 Long-term yield levels are approaching the coveted 5.00% ceiling providing good support as retail investors will come back to the market along with cross over buyers.

  • Tax rates have gone up, and are roughly 43.4% for top tax payers (39.4% federal income tax, and 3.8% Medicare tax). This has yet to be reflected in the market.
  • Credit quality continues to improve as the economy continues to grow in the face of fiscal head winds.

MainLine encourages investors to continue to invest during these windows of opportunity that 2013 is providing. This recent opportunity was unexpected, and therefore its impact is settling in. The yields now available are much more attractive long-term, and for some investors it may be time to venture away from the defensive strategies we have recommended. The ability to book a long term 5% tax exempt yield (over 9% tax equivalent for top tax players in high income tax states), is a historically proven long-term winning investment strategy.

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