2011 First Half Review
Clinton Investment Management
By Andrew Clinton
September 26, 2011
A dramatic recovery in the municipal bond market took hold during the first two quarters of the year. Solid retail and institutional demand for tax-free bonds, together with meaningful declines in new issuance and increase in state tax receipts, set the stage for a significant rally. While long-term municipal bond funds continued to experience significant volatility in shareholder redemptions and or subscriptions, municipal yields fell across curve. Ten year muni yields reached a high of 3.46% on January 18th. By the end of the second quarter, rates had fallen by over 65 basis points (bps) in the 10 year area of the curve while yields for 12 year securities declined by almost 100 bps. The Barclay’s Cap 20 Year Index returned over 6.00% during the first six months of the year, clearly illustrating the power of the recovery. Municipal bonds actually outperformed Treasuries during the first six months of the year. For example, ten year municipal bond yields fell at a rate that was roughly five times greater than commensurate Treasuries, see Figure 1. The outperformance of municipal bonds can largely be attributed to lower new issuance together with the efforts of state and local governments who endeavored to cut spending and services. Municipalities also enjoyed higher tax revenue as a result of improved economic growth combined with higher tax rates put in place over last two years.
Figure 1. Change in Interest Rates 12/31/10-6/30/11
Negative price performance and extraordinary volatility inherent in global equity markets continue to plague investors, calling into question, once again, whether the risk associated with investing in stocks and or risk assets is worth the “potential” reward. Slow growth, a poor jobs market and disappointing equity returns increasingly call into question the conventional wisdom that high asset allocations to risky assets are in the best interest of wealthy investors.
While yields on tax-exempt municipal bonds are lower than they have been in some time, there remains a strong argument for investing in tax-free investments that deliver actual cash flow. In addition, given the municipal bond market’s historically stable credit history, illustrated most recently by states’ and local governments’ demonstrated willingness and ability to make difficult choices in order to protect debt holders, we would argue that investing in municipal bonds today is particularly compelling given the opportunity to achieve attractive relative return.
Going forward we expect there to be continued uncertainty surrounding economic conditions as well as concerns relating to the European debt crisis. As a result of this ongoing uncertainty, we expect both economic growth and US interest rates to remain low for some time. We continue to seek out municipal bonds, on behalf of our clients, that provide a higher degree of income, as well as stable, underlying credit quality. We are fully aware of and appreciate the essential role that municipal bonds play in our clients’ investment portfolios. Therefore, we will continue to invest conservatively in an effort to maximize our clients’ total-rate- of-return. Please do not hesitate to contact us should you have any questions.
(c) Clinton Investment Management
