8/12/13 – Opportunities in the Fixed Income Landscape

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Aug 12, 2013 7:22:47 AM

and tagged Market Updates

Leave a comment

— Guest post from Peter Essele, senior investment research analyst

After the large uptick in rates and subsequent outflows from fixed income funds, the waters seem to have calmed recently, and investors are now beginning to move back into the space. One area, however, has continued to see outflows. While the taxable side of things only witnessed 4 weeks of outflows before a return to positive flows, the municipal bond category has recorded 13 straight weeks of outflows. Why is this happening?

Well, for one, the municipal market is primarily made up of retail investors, who often dive for the trenches when volatility shows its ugly face. Performance has been relatively lackluster in this space relative to a lot of other areas, so safe-haven investors appear to be moving monies elsewhere.

Second, the Detroit bankruptcy announced a couple of weeks ago was the coup de grâce, resulting in lower prices and higher yields across many sectors. Fortunately, this can create a great opportunity for astute investors.

To address the relative value of municipal securities to other fixed income securities, we have constructed the chart below, which shows the yield difference between the Barclays Aggregate Municipal Bond Index and the Barclays Aggregate Credit Index. Essentially, it’s the yield you get on an average municipal bond minus the yield you would get on a corporate bond. As the chart shows, the yield for municipal bonds is hovering right around the yield you’d get on a comparable corporate bond. If you factor in the tax advantage of municipals, your after-tax yield would actually be much higher. The last time we saw relative yields in this range was during the “Meredith Whitney era,” when municipal prices took a nosedive following erroneous predictions by an analyst who wasn’t at all familiar with the municipal landscape.

We’re not necessarily predicting that investors who enter this space will see outsized returns like they did during the buying frenzy in the aftermath of Whitney’s comments, but, on a relative basis, municipal securities certainly look attractive. My impression is that valuations will revert to post-crisis levels sometime in the near term, which either means that municipal prices will be bid up or corporate bonds will sell off.

081213_1

 

 

 

 

 

 

 

 

 

 

 

Source: Barclays/Commonwealth Investment Research

Corporate bonds contain elements of both interest rate risk and credit risk. Municipal bonds are federally tax-free but may be subject to state and local taxes, and interest income may be subject to federal alternative minimum tax (AMT). The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.

The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. Barclays Capital Global Aggregate Credit Index (Hedged USD) is an unmanaged Index that provides a broad- based measure of the global investment- grade fixed income markets. The three major components of this index are the U. S. Aggregate, the Pan- European Aggregate, and the Asian- Pacific Aggregate Indices. This index excludes Government and Securitized Securities. The index also includes Eurodollar and Euro- Yen corporate bonds, Canadian securities, and USD investment grade 144A securities.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®