David Kotok of Cumberland Advisors argues that the recent fall in munis represents a great buying opportunity.Here are four reasons why:
1) This has not been credit-driven. This is long-maturity bonds following Treasury yields higher, and driven by the confluence of uncertainty regarding BABs legislation and the resulting supply bulge. This is not inflation-driven. Twelve-month trailing inflation is 1.1%.
2) In a world where a 30-year Treasury is 4.35 to 4.40%, a long, high-quality tax-free bond yielding 5% is a taxable-equivalent yield of almost 7.7%. It is much higher when state taxes are also figured in. And many high-quality issues are trading cheaper than 5%.
3) The normal December and January demand from reinvestment and maturing and called bonds could be in the $35-40 billion area. That is in front of us. A lot of first-quarter supply is being pushed into this quarter. That will be behind us. And there is certainly a chance that Congress does extend BABs, albeit at a lower subsidy rate.
4) If longer Treasury yields continue to climb and tax-free yields eventually return to some degree of normalcy versus Treasuries (as happened in April of this year), there is the chance for many 5.50 to 6.50% coupons to be prerefunded by their issuers. Cushion bonds have been beat up in this market, as well, and offer very compelling values. We believe this is the best opportunity in over a year for long maturity tax-free bonds, and are acting accordingly.
In summary, this is the cheapest that tax-free bonds have been in over a year. This is driven by factors that are unrelated to normal bond market movements such as inflation, employment, etc. We believe this is the best opportunity in over a year and are acting accordingly.
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