High-yield municipal bonds and related exchange traded funds have been rallying alongside the strongest run-up in speculative debt since 2009, and now, Morgan Stanley (NYSE: MS) is sounding a warning.
Michael Zezas, chief muni strategist at Morgan Stanley, argued that the outlook for speculative-grade bonds to continue to beat the market is diminishing, Bloomberg reports.
Investors have piled into the municipal bond market this year due to a dearth in new muni issuance and increased demand for tax-free securities. Junk-rated local debt has returned 9% so far this year, the strongest start to a year since 2009, whereas the broader market has rallied 5.7%. [Low Supply Supporting Munis ETFs With Yields at 11-Month Lows]
The Market Vectors High Yield Municipal Index ETF (NYSEArca: HYD), which has a 5.18% 30-day SEC yield or a 8.58% taxable equivalent 30-day SEC yield for the highest income bracket, has gained 9.5% year-to-date. HYD includes some investment-grade BBB-rated debt at 21.6% of its portfolio, along with 24.7% in junk-rated BB, 15.9% in B, 2.2% in CCC and 42.7% in 34.0% in non-rated debt.
Additionally, rival SPDR Nuveen S&P High Yield Municipal Bond ETF (NYSEArca: HYMB), which has a 4.75% 30-day SEC yield or a 8.38% taxable equivalent yield, has increased 11.9% year-to-date. HYMB includes more investment-grade debt, such as Aa 0.4%, A 17.4%, Baa 23.8%, along with junk-rated below Baa 37.2% and not rated 21.1%.
In contrast, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), which has a 1.89% 30-day SEC yield or a 3.34% taxable equivalent yield, is up 6.0% so far this year. MUB only includes investment-grade municipal bond debt. [Investors Flocking to High Yield Muni ETFs]
Now, Zezas warns that high-yield debt could see problems ahead as demand slows and municipalities increase bond sales. Consequently, the strategist suggests high-yield muni investors should “move from overweight to neutral” relative to their benchmarks.