Municipal Bonds Stand Firm

A week before the powers that be in the nation's capital mercifully managed not to default on Treasury debt, one of my favorite tax-exempt bond managers, Eve Lando, of Thornburg Funds, said to "run, not walk" to municipal bonds. 

She noted that state and local bonds had moved little in price and yield all spring, despite the prospect that the federal government might suffer a "technical" default – meaning a day or two of weirdness and trading losses before Congress would belatedly raise the debt limit and agree to make all U.S. bond investors whole.

Because municipal borrowers rely on enormous direct federal grants or in-direct federal support (such as the presence of Treasury bonds in escrow to buttress the munis' timely repayment of principal), the tax-exempt world should have come under heavy pressure. And yet it stood firm. If municipals can stare down credit-market Armageddon, well, what's a little mild recession talk?

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My answer: not much. State and local finances are in fine shape, the tax-equivalent yield of most municipal bonds is more favorable compared with Treasury bonds than it was a few weeks ago, and although new tax-free bond issuance is not especially light, the supply-demand balance is friendly enough to favor investors. 

The main thing holding back municipal returns is continued net selling by holders of mutual and exchange-traded funds, likely the consequence of higher interest rates on bank savings and, until lately, on Series I savings bonds. But those headwinds are overdue to reverse direction, especially if the Federal Reserve quits hiking short-term yields. Even if you worry that the economy (or most segments of it) will slow markedly or recede in the second half of 2023, that stands to harm investment-grade corporate and high-yield bond prices more so than municipal bonds. 

I presume that most readers, other than young people just starting to build their IRAs and 401(k)s, have a stake in tax-exempts. If you do, I advise against selling any of them. If you acquire cash to reinvest from a refunded bond or a matured stage of a bond ladder – or some other lump sum – I deem tax-exempts worth considering as an alternative to another round of six-month CDs and certainly to Treasuries of all maturities.

What should municipal bond investors buy?

The question becomes how best to invest. A well-regarded actively managed municipal fund, such as the Baird Strategic Municipal (BSNSX) or the MainStay MacKay Tax-Free Bond (MTBAX), not only gets you a tax-free yield of 3% or a little more, but in the first week since the Biden-McCarthy treaty, plenty of such funds had already padded their total returns by about one percentage point. 

Residents of high-tax states such as California, New Jersey and New York likely need no reminder to seek out home-state bond funds, but I'll just say here that they are also compelling. For example, the Fidelity New Jersey Municipal Income (FNJHX) gained 1.3% in the first week free of debt-ceiling drama. 

For serious risk takers, the redoubtable Nuveen High Yield Municipal (NHMAX) is on a roll, up 1.7% in one week and 3.5% for the year to date; the distributions work out to 5.4% annualized. Legendary Nuveen manager John Miller just retired, but the bench is deep and his successors long-established. 

As for individual bonds, I screened my Fidelity brokerage account and found more than 200 listings with yields to maturity in 10 to 20 years of 4.25% or more; ratings no worse than A-minus by Standard & Poor's or A3 by Moody's; and familiar and generally reliable revenue streams from sources such as water and sewer systems, local school systems and state highways. My favorite tax-exempt subcategory, toll road bonds, are well represented. 

A batch of North Carolina Turnpike Authority 3% bonds due in 2042 flashed on my screen for 82 cents on the dollar (up from 78 cents two weeks ago), with a yield to maturity of 4.4%. The bonds are insured, so the ostensible rating is AA. An equivalent Treasury bond is priced to yield 4%. 

But after the drama we just went through, you have to ask whether it is easier or harder to dodge a turnpike toll booth than it is to threaten to skip out on the government's debt. Just sayin'. 

Note: This item first appeared in Kiplinger's Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

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