After hard, fast run-up, muni bonds cooling off
The tax-free municipal bond market has had the wind at its back for the last five weeks, driving yields down and bond prices higher. But that may be changing.
Selling in the muni market has picked up since Friday. Some investors who were lured by high bond yields in mid-December now are balking as yields have dropped.
In the California muni market, “It’s certainly a lot harder to find a bargain now, that’s for sure,” said George Strickland, a muni bond fund manager at Thornburg Investment Management in Santa Fe, N.M.
The market’s rally starting in mid-December was “very hard and very fast,” said Steven Permut, a muni fund manager at American Century Investments in Mountain View, Calif.
That has helped many muni investors recoup most of the paper losses they incurred in the fall market meltdown, as the credit crisis deepened and muni and corporate debt was dumped indiscriminately, depressing bond values and sending yields soaring.
The share price of the Vanguard California Long-Term Tax-Exempt bond fund, for example, plummeted 13% from $11.24 on Sept. 11 to a low of $9.77 on Dec. 16, then rebounded 10% to $10.74 by Jan. 15. But the share price has fallen every trading day since then, closing Wednesday at $10.54.
As for interest rates, the Vanguard fund’s estimated annualized dividend yield was about 5.1% at the share price low in mid-December. It’s now about 4.7%.
That’s still a good tax-free return, particularly compared with yields on U.S. Treasury securities. But analysts note that one of the factors that triggered selling of munis in early December -- worries about the deteriorating finances of many municipalities as the economy worsens -- hasn’t gone away even as yields have dropped.
California is an epicenter for those concerns, given the state’s massive projected budget deficit, which Gov. Arnold Schwarzenegger and the Legislature still haven’t addressed.
The state can’t default on its general-obligation bonds; the California Constitution requires that the state honor those debts.
Nonetheless, Moody’s Investors Service said late Wednesday that it might downgrade California’s general obligation bonds, currently “A1.” That would give the Golden State the lowest rating among the 50 states. California now shares last place with Louisiana.
And Sacramento’s dire money woes, and the economy’s slump in general, are likely to make things tougher in 2009 for California cities, counties and other municipalities that don’t have constitutional guarantees on their debts.
Although the vast majority of municipal bond issuers will pay as promised, market professionals expect an uptick in muni bond defaults in the next few years. That will create more “headline risk” -- meaning that, skittish investors, reading scary headlines, may periodically demand higher yields on muni bonds to compensate for higher perceived risk.
One factor buoying the muni market in recent weeks has been the possibility that the federal government will help insure muni securities or buy them directly.
But Bob Gore, a muni trader at Crowell, Weedon & Co. in L.A., says he wouldn’t bet on a further rally. “The easy money has been made,” he said.
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