The municipal market’s biggest July decline in a decade is leading investors such as Vanguard Group Inc. to bet history is on their side as they buy with yields close to a two-year high.
Tax-exempt debt fell about 1 percent in July, the worst performance for the month since 2003, Bank of America Merrill Lynch data show. If the past is any guide, the trend for munis is poised to reverse in August: Only once in the past 24 years has the market declined in both months.
Benchmark 10-year munis yield 2.91 percent. That’s about 112 percent of interest rates on similar-maturity Treasuries, where the average since 2001 is 93 percent. For Chris Alwine at Vanguard and Rick Taormina at J.P. Morgan Asset Management, which oversee a combined $135 billion in munis, the elevated ratio is a signal to add tax-exempt securities.
“Municipal bonds are relatively cheap, and we’re seeing people come in and take advantage,” said Phil Fischer, head of muni research at Bank of America in New York. “While this is typically a strong period for muni performance, this is not a strong year. Mutual-fund flows continue to be strongly negative and we had a shock from the Detroit bankruptcy.”
Defying History
The $3.7 trillion municipal market has typically gained in July and August as investors receive cash from coupon and principal payments while issuance dwindles.
Yet demand from individual investors, who own about 70 percent of local debt either directly or through mutual funds, collapsed over the past two months as a growing economy fueled bets that interest rates will rise. Individuals pulled $11.8 billion from all muni mutual funds in the past month, the most since at least 1992, Lipper US Fund Flows data show.
Just as withdrawals began to slow, Detroit sought court protection on July 18. The move led Meredith Whitney, founder of Meredith Whitney Advisory Group LLC, to write an article in the Financial Times saying Detroit’s filing “should not be regarded as a one-off” in the municipal market.
The banking analyst incorrectly predicted in December 2010 that there would be “hundreds of billions of dollars” of muni defaults in the following 12 months.
Whitney Wave