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.
“For some of these riskier trades that have done well, there are only marginal benefits” going forward, Zezas said in the article.
Morgan Stanley is the latest financial firm to question the sustainability of the municipal bond rally, joining Citigroup (NYSE: C) and the Vanguard Group.
Market Vectors High Yield Municipal Index ETF
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.