Municipal Bonds: The First “Obama Investment”
by Alexander Green, Chairman, Investment U
Friday, June 20, 2008: Issue #810
A reporter from Bloomberg called me last week to interview me about Treasury inflation protected securities or TIPS.
I told him he was looking at the wrong part of the fixed-income market.
Sure, food and energy prices have been soaring. But so have TIPS. They are up substantially from where they were a year ago.
I warned a few months ago that these bonds had gotten ahead of themselves. And, sure enough, iShares Lehman TIPS Bond Fund (AMEX: TIP) – the leading inflation-protected index – has pulled back roughly 6% from the highs of three months ago.
My guess is that they have further to fall still. After all, 10-year TIPS yield only 1.56%. Five-year TIPS yield less than 1%. That’s an awfully steep price to pay for inflation protection.
No, the real bargains are still in municipal bonds. You should consider these even if you’re not in a top tax bracket. Here’s why…
Get A Higher Yield With Municipal Bonds
Right now a taxable 10-year Treasury bond yields 4%. So does a Triple-A 10-year tax-free municipal bond. If you’re paying any taxes at all, you’re getting a higher real yield on the municipal bonds.
(Earlier this year I was pounding the drum that municipal bonds were yielding even more than Treasuries, a rare opportunity. But that discrepancy is now gone.)
There is another reason to buy municipal bonds right now.
We’ll have a new President in seven months. The polls currently give Obama a slight lead over McCain. And history shows a two-term President is usually followed by a President from the opposite party. (Bush the Elder was an exception. The country wanted to re-elect Reagan again, but had to settle for his Vice President.)
Obama has promised to raise the top marginal tax rate back to the old Clinton rate of 39.6%. A Democratic Congress will be eager to comply.
If you’re not in the top bracket, you may think this is of no great import. But it will be important to high-income earners. They are likely to look favorably on tax-free bonds. And since the supply of tax-free bonds isn’t likely to increase substantially between now and then prices may well head higher. (And thus yields will go lower.)
This strategy is not based solely on an Obama win, incidentally. If McCain wins and tax rates remain unchanged, most investors will still prefer tax-free income to taxable income.
Municipal Bonds: Playing the “Obama Investment”
How do you play the municipal bond market now? You have several choices:
- You can buy individual tax-free bonds. However, there are liquidity issues here as well as spreads and commissions to consider.
- There are dozens of no-load, tax-free choices at Vanguard, Fidelity and other major fund companies. (Including single-state funds for those of you in high-tax states.)
- There are deeply discounted closed-end bond funds that trade on the New York Stock Exchange like Van Kampen Muncipal Trust (NYSE: VKQ) yielding 5.5% or BlackRock MuniYield Quality Fund (NYSE: MQY) yielding 5.1%. (You can always check the discount to net asset value by visiting ETFConnect.com.)
- Or you can buy one of the new municipal exchange-traded funds like iShares S&P National Municipal Bond Fund (AMEX: MUB) or S&P National Municipal Bond iShares (NYSE: MUS). (These ETFs yield less than closed-end fixed-income funds but are generally less volatile since they trade close to NAV and don’t use leverage.)
In short, if you prefer tax-free income to taxable income – and who doesn’t? – you should pick up a few.
And if you think Obama is likely to win in November… maybe you should pick up a few more municipal bonds.
Good investing,
Alex
Today’s Investment U Crib Sheet
It’s not uncommon to see stocks get a lift ahead of the presidential election. But whether we experience a pre-election rally or not this year, it’s important to know the difference between cyclical and non-cyclical stocks… especially if we are in the midst of a recession.
- Cyclical – A cyclical stock follows the market upward as businesses and consumers spend money. Examples of these are automobile and technology companies. During the good times, these industries benefit from increased spending and business expansion. However, cyclical stocks also follow the market’s direction. So if the economy and the market are plummeting, so will the cyclical.
- Non-Cyclical – These companies and stocks are also called “defensive” because they do well in times of economic downturn. Generally, these companies have products that are needed regardless of the business cycle. Companies like utilities, non-durable goods companies (we’ll always need toilet paper, toothpaste and other daily products) and defense contractors are considered non-cyclical. Regardless of where we are in the economic cycle, there will always be investment opportunities… especially if you look beyond the U.S. border.
Related Investment U Articles:
- Would You Like a AAA-Rated, Insured Bond With An 8% Yield?
- Why Fears of a Municipal Bond Collapse Are Overdone
- High-Yield Bonds Are Shining Brighter Than Ever!
- TIPS Are the Proof of The Fed Distorting the Financial Markets
- Treasury Inflation-Protected Securities (TIPS): The Indispensable Investment
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Alexander Green is the Chief Investment Strategist of Investment U. A Wall Street veteran, he has more than 20 years of experience as a research analyst, investment advisor, financial writer and portfolio manager.
