In the wake of the concerns stemming from Detroit’s bankruptcy filing, yields on municipal bonds have soared–even those with impeccable credit quality. In fact, according to Anthony Valeri, Fixed Income Strategist for LPL Financial, the taxable-equivalent yield on 10-year, triple-A-rated municipals has nearly matched that of Baa corporate bonds.
“The near-similar yields, after accounting for the impact of taxes, show that current municipal bond pricing is depressed to the point that investors are disregarding credit quality differences. The last time the [taxable equivalent yields] of high-quality municipals and middle-tier rated corporate bonds converged was in late 2010 and early 2011, following dire prognostications on the market from Meredith Whitney that induced a sell-off,” he writes.
What’s more, the default rate on medium-grade Baa municipals since 1970 has been lower than that of top-tier Aaa corporates, Valeri also points out, 0.16% versus 0.50%. To be sure, state and local governments face far greater challenges than in the past four decades, notably unfunded pension liabilities. None of which is new news, however.
With the relative pricing of tax-exempt munis out of whack with taxable counterparts, crossover buyers have emerged to take advantage of munis’ cheapness, he adds. That should help to spur an improvement in relative performance of the municipal market.
“We continue to believe current municipal valuations provide an opportunity for patient bond investors and an attractive alternative to corporate bonds with the added benefit their tax exempt status kicked in for no additional cost,” Valeri concludes.
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