For 13 consecutive months (January 2014 to January 2015) the returns on municipal bonds as measured by the Barclays benchmark indices were positive: A wonderful run but practically unsustainable. Returns were negative at the end of February, reflecting uncertainty about the near-term plans of the Federal Reserve ( the “Fed”) as well as a more robust presentation of new issues from municipalities. February can be summed up this way: The Fed continued to wait for a trigger to finally signal a move to higher rates. That circumstance provided the ideal backdrop to a higher seasonal issuance of bonds, that throughout the month caused yields to rise. Fresh cash entered the market, but given the uncertainty of the timing of the Fed’s move, the market demanded higher yields (lower prices) to place bonds.
Source: Barclays.
Corrections occur in virtually all markets and not all for the same reasons. In this case, it was logical for municipals to follow the trend of Treasuries throughout the month. I’ll suggest that because little has changed fundamentally, this correction was needed, in my view, to continually focus investors on the inherent value that municipals currently present.
I have spoken many times in the past about the taxable-equivalent calculation offering a true means of authenticating relative value. This condition remains in place. I continue to believe municipals remain a valuable asset class in an asset allocation model. One month does not a trend make and I suggest further that you embrace the possibility that an uptick in supply has generated more attractive entry points for new cash. Consider staying the course with municipals in order to continue to realize the potential benefit of tax-free income.