Time to buy munis?

I’ve been looking at municipal bonds recently. Whenever I see a large sell off in any asset class accompanied with a lot of media hype the contrarian hairs in the back of my neck tend to perk up. All markets tend to over react more often than not. These over reactions can give patient long term investors great opportunities. So, the question I posed to myself recently was ‘are municipal bonds a good value right now?’ Lets find out.

Most investor have heard about the sell off in municipal bonds, driven by the ‘crisis’ in state, local, and municipal governments. I encourage you to look at the Meridith Whitney interview on 60 minutes to get a nice summary of the bear case for munis. Or this article gives a great summary picture of the potential problem. Because of these concerns muni bond prices have fallen significantly since September of 2010, about 10%, which is quite a big move for a government bond index. For example the muni bond ETF, MUB, is off about 10% since that time. As long term investor the first thin I do is turn to history as a guide.

I went to the federal reserve website and downloaded historical data on municipal bond yields and the 10yr US treasury note to compare the relative prices of these two bond types. Long term perspectives can give an investor some great insights. Here is a chart of the spread between 20yr muni yields vs 10yr US Treasury yields going back to the mid 70s.

As the chart shows the average spread over time is about negative 1% and the 90th percentile point of the spread is 0.66%. The spread as of the end of 2010 is now1.61%! Only in the financial crisis of 2008 have spreads been this high. At least by the indication of the spread to government bonds munis seem to offering some value. For example, you can buy the municipal ETF, MUB, at a tax free yield of 3.76% (5.1% tax equivalent yield @ 25% tax bracket) as compared to the US long bond ETF, TLT, at a yield of 4.15%. Or you can buy one of the best muni funds in the business, FTABX, at a tax free yield of 4.21%. There is definitely an indication of value at these prices. Of course, if the nightmare story of defaults comes to fruition these yields could turn out to be value traps.

There are indications that the muni sell off is an over reaction and that the problem at the states and local level is not as bad as people fear. A note from value investors, Cumberland Advisors, makes its case for an over reaction here. They say;

The tax arbitrage test in Muniland is at an extreme.  At a 35% federal rate, the entire curve of Muni yields from 3 months to 30 years is higher than treasuries.  In fact, this is true when tested at the 25% tax rate.  Such a comparison is extraordinary and rare.  Climax?

And as it turns out, very quietly, state/local revenues are starting to turn.

The U.S. Census Bureau tracks the various line items of receipts for governments, and the news is that in the third quarter of 2010 on a year-over-year basis total tax receipts were up 5.2%, from $270.2 billion to $284.3 billion. As the graph below shows, clearly there is seasonality to these numbers, but municipal revenues in the third quarter 2010 are just below the record for any third quarter, set in 2008.

Also, the bond king himself, Bill Gross, agrees and has been buying munis with his own money. In general, I think people are forgetting the revenue generating power of state/local governments and the many constitutional protections for muni bond investors in most states.

I summary, there seems to be significant value in municipal bonds right now. The sell off seems to be over done and the yields offered by tax free munis vs taxable treasuries is extremely compelling. A conservative income investor could do quite well with an investment in munis today. And for the more aggressive income investor muni closed-end funds offer even higher tax free yields for not much more risk. Even compared to taxable junk bond funds or their taxable CEF bretheren, muni CEFs seem right for the picking. Now I just need to convince myself that they offer better returns for the risk than selling options on under valued stocks.


Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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11 Responses to Time to buy munis?

  1. David Fleischer says:

    Hi Paul,

    I hope the New Year has started off well for you and Nina. It has been a while since I have commented on one of your postings and I have been a little behind, but they do all get read, eventually!

    You mentioned closed end Muni funds. Are there any you recommend?

    Also, I know you sell a lot of options. Is there a good book you can refer me to on this?

    Best Regards,


    • libertatemamo says:

      Hey David. As far as muni CEFs, the best place to look is http://www.cefconnect.com, they have the best data and search tools for all types of CEFs. The two biggest CEF companies are Nuveen, Eaton Vance, and Blackrock, They all have some good funds. Use the fund screener to search for national muni funds. The you can sort the list it gives you by yield, discount to NAV, leverage, etc… NXZ, BBF, NZF are a few that look good. I bought some NXZ recently. Just never buy any CEFs when they are trading above net asset value (NAV).

      I should prob do a post on this…..

      Hope that helps.


    • libertatemamo says:

      Hey David, forgot to answer your options question. Don’t spend your money on any books, yet. Check out the on-line options tutorials at places like the CBOE website, OptionsXpress, or your broker. Also check out the website Options for Rookies by Mark Wolfinger. If you like what you read on his site you can buy one of his books.
      You only need to master two options trades at the beginning; cash-secured puts and covered calls. These are the bread and butter option trades to generate income. They are the two I use 90% of the time. Nothing fancier.


  2. R says:

    Hello Paul, I enjoy reading your blog and find it extremely informative.
    I have to admit I am scared to death of some munis now, I was listening to the Gov. Of NJ talking about the cuts they are making to bring their budjet in order and if I heard him correctly they will only cut there 60 billion of liability in half over the next 15 YEARS? I often wonder if they will pass legislation so they can chapter 11 a state?
    I also never thought I would see the old GM default on their bonds. It kills me to see there stock holding where it is. Keep up the Good work I enjoy the writing.

    • libertatemamo says:

      Hi Ron. Sorry it took a bit of time to respond. We had a long drive in the RV today.

      I can understand your fear of investing in munis right now. Often the most under valued investments make you want to throw up, literally. I try to remember one of Buffet’s many great investment sayings, ‘be greedy when others are fearful, and fearful when others are greedy’. However, you need to be able to sleep at night. Every investor has their own threshold of where that not sleeping at night point is and everyone needs to pay attention to it.

      The revenue turn around at the state level is encouraging but not anywhere yet where it would cover the short fall. I don’t think a bill to let the states default will pass. Politicians aren’t stupid. I think they realize the bond investors will come out rosy out of any bankruptcy proceedings and the state’s interest costs will skyrocket. Then what will they do.

      Personally, I took a small position in a muni CEF just to test the waters and see how things ago. I’m also considering going long TLT (long term treasuries as a hedge). If the economy continues to go ok, munis revenue will keep growing and things will be relatively ok. If the economy turns, munis aren’t going to get hit that much harder than they already have been hit, and TLT will go up significantly in this scenario.

      Anyway, just throwing out some thoughts.


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  4. David Fleischer says:


    Thanks for the info on the options web sites. I will look at them.

    Can you share with your readers which Muni CEF you bought?


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