This week’s default by the city of Stockton, California prompted us to take another look at how municipal bonds are performing for most investors. The Stockton default is the largest default of any city government in U.S. history. It seems not to be, however, representative of the municipal bond market as a whole.
A recent conference, featuring the following insight from Nuveen Investments, provided details on the current municipal bond market and presented some positive trends:
- State governments have had increases in revenue each quarter since the first quarter of 2010.
- So far in 2012, 15 of the 50 states have had higher than projected revenue growth, 22 other states have had revenue growth that is in line with projections while seven states have experienced lower than expected revenue growth. (Not all states are included because some don’t report intra-fiscal year data.)
- It is expected that about $350 billion in new municipal bonds will be issued during 2012. This is an 18% increase over 2011.
- The default rate of municipalities is much lower over every time period than the default rate of corporations. In fact, over the past 10 years, the default rate for AAA-rated corporate bonds is actually greater than the rate for Baa rated municipal bonds. (see chart)
- Yields for high-quality municipal bonds are at all-time lows. As of the end of May, the average yield for a 10-year bond for an AAA-rated municipality was just 1.75%. Thirty-year bonds from the top-rated municipalities earned just 3.04% per year. In spite of this, the yields of municipal bonds with both 10-year and 30-year maturities compare very favorably with the yields of U.S. Treasury bonds with the same maturities. They are taxed differently, however. The edge for municipal bonds grows for individuals at higher tax brackets.
- The return spread for municipal bonds of the same maturity but different quality is at historically high levels. The return of the Barclays AAA Municipal Bond Index was 2.33% as of May 31while the return of the Barclays High Yield Municipal Bond Index was nearly four times higher at 8.87%.
- The Barclays Municipal Bond Index had a positive total return over each of the past three periods when the Federal Reserve raised interest rates.
- Best of all from an advisor’s standpoint, from July 1, 1999 to March 31, 2012, the correlation of returns of the Barclays U.S. Municipal Bond index and the S&P 500 was -.01. This low figure helps reiterate that municipal bonds are a good diversifier for most investment portfolios.
~ Allyn Hughes — Brooks, Hughes & Jones — Partners in Wealth Management, Tacoma, WA
Past performance is no guarantee of future results.