Muni Bonds Defy Forecast, Lose Value Again in January

The stock market wasn’t alone in disappointing investors in January: The tax-free municipal bond market also defied expectations for a January rally, instead turning in its 12th straight losing month.

Many investors were looking for a “January Effect” rally in muni bonds. Traditionally munis have rallied in the first month of the year, meaning interest rates have declined and bond principal values have risen.

That has often occurred because fewer new bonds usually are sold at the beginning of the year, while potential buyers are flush with cash from interest payments on existing bonds.

Also, tax-related selling of bonds that occurs at year-end, as investors take losses or gains, abates once Jan. 1 arrives.

Since 1986, muni bonds overall have risen in value 11 times in January and fallen just three times, according to the Bond Buyer 40 index.

The effect was expected to be even more pronounced this year because of the heavy pressure to sell munis for tax-loss purposes late last year, as all bonds were depressed by the rise in market interest rates during the year.

But muni bond mutual funds, which saw a huge net outflow of $7.2 billion in capital in December, have continued to experience redemptions this month, as investors continue to pull out.

“Funds have had horrendous bleeding that doesn’t show any signs of letting up,” said Suzanne Greenberg, who helps manage about $450 million in bonds for Cumberland Advisors in Vineland, N.J.

“Funds are not buying” and individual investors are still more interested in the stock market, she said.

For all of 1999, muni bond mutual funds saw a net $12.1 billion outflow of capital, according to the Investment Company Institute. The funds’ total assets as of Dec. 31: $272 billion.

The average muni bond fund posted a negative total return of 4.8% last year, meaning the decline in share principal value because of rising market interest rates offset interest earned.

“After a difficult year last year, people believe past is prologue,” said Paul Disdier, a muni manager at Dreyfus Corp. in New York. “This selling will continue for a while.”

The good news--at least for investors interested in buying muni bonds now--is that the continuing rise in yields is making for very attractive taxable-equivalent yields.

As measured by the Bond Buyer 40 index, the annualized yield to maturity of long-term muni bonds nationwide now is 6.31%, near the highest level since May 1995.

To an investor in the 31% federal marginal tax bracket, that is equivalent to a 9.1% yield on a taxable bond, such as a Treasury issue or corporate issue.

But what happens next with muni yields, as with other bond yields, may depend on how high the Federal Reserve (which meets today and Wednesday) decides to drive short-term interest rates. If the economy were to slow, the Fed conceivably could ease off on the rate pedal--and bond yields in general would be expected to decline, as investors lose their fear of a rebound of inflation.