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Are municipal bonds cheap? Based on one metric"”the ratio of muni-bond yields to Treasury yields"”they certainly look that way. But investors should use caution before rushing to buy.
The average five-year muni bond are yielding about 1.35%, 1.27 times more than the five-year U.S. Treasury note, according to Barclays Capital. That's the biggest ratio of 2011 and nearly double the 0.69 times reached in mid-May. Other munis are also trading well above the equivalent Treasury, with ratios near the year's highs.
Before the financial crisis, anything over 0.9 times would have been a buy signal, says Elizabeth Fell, U.S. fixed-income strategist at Barclays Wealth in New York. But the market has changed since then, and investors are still trying to figure out what the new buy signal should be"”or whether one even exists.
These days, investors have to understand why the gap has widened, not just that it is wide. And despite such headwinds as the Harrisburg, Pa., bankruptcy filing and an uptick in issuance, the primary reason for the wide gap is the Treasury market.
Treasurys, for instance, have benefited from the flight-to-quality trade, which has sent investors from all over the world scurrying into the supposedly risk-free bonds. While munis typically move in sympathy with Treasurys, they are bought primarily by Americans"”and mainly those in the highest tax brackets.
"When the world is coming to an end, people buy Treasurys," Ms. Fell says. The Fed has also been buying Treasurys, which has artificially depressed their yields, perhaps widening the gap between the two as well.
The upshot: Treat with skepticism anyone who claims munis are cheap solely based on their yield relative to Treasurys.
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We want to “treat with skepticism anyone” who bashes municipal bonds. Meredith Whitney did just that and it was followed by piling on of supposed financial journalists. Defending Whitney's call at this point is very much like defending Harold Camping's prophesy on May 22nd, after even the most gullible people have realized that they euthanized their pets for nothing. Generally speaking, state and local governments are experiencing policy crises, and not debt crises. Who really cares about the intransigent doomsday believers that remain, for whom a forceful narrative has always been more relevant than facts?
Total Return covers the latest personal-finance and investing news and trends, helping readers make sensible money decisions in a complex financial world. Send your comments, feedback and questions to totalreturn@wsj.com.
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