Although November’s rally is behind us, there’s still time to capture seasonal return opportunities
Muni market volatility can significantly add to long-term returns
Record monthly returns are hard to come by in MuniLand. Unlike the stock market, where about 8 to 15 trading days a year determine most of the cumulative annual return, the municipal market tends to have steady monthly returns; however, there are times when the stars align and provide an opening to allocate capital when market’s temporarily experience irrational exuberance.
Last month, a technical market indicator, which also occurred last year, provided municipal bond investors with an excellent opportunity. When mutual fund outflows accelerate and above-average negative returns ensue, it is like clockwork that similar positive returns follow shortly after. This valuation gap presented itself in November, and it is one of the best times to purchase municipal bonds.
The bond selloff during August, September, and October resulted in a historic negative rolling 3-month return of -5.14%. At the same time, municipal mutual fund flows turned negative, confirming the contrarian indicator. As a result of yields adjusting by the end of October to levels not seen since 2007, investors piled back into fixed income, causing yields to decline rapidly and resulting in the highest monthly return in the history of the municipal market of 6.35%.
As demonstrated by the chart below, these corrections happen quickly.
Deck the Halls with Seasonal Municipal Returns
The holiday season coincides with a seasonal pattern in the municipal market that, although not as powerful as the outflow/negative return technical indicator mentioned above, provides a sound basis for putting money to work now. As supply dries up towards the end of the year, demand tends to increase as investors are looking to finalize any portfolio rebalancing prior to year-end. In addition, the thin staffing on trading desks due to holiday vacations, typically provides a firmer tone, as traders are reluctant to sell bonds at a disadvantage.
Although new issuance tends to pick up in January, the significant amount of bonds maturing and coupon payments that need to be reinvested typically overwhelms the supply that comes to market. There is also a modest number of investors that rebalance their portfolios at the beginning of the year, once all the year-end return numbers are locked in.
As demonstrated in the chart below, the average return in December and January is 0.95%. Based on the history of this seasonal opportunity, investors could realize a return of roughly 1.00% for the two-month period if the averages hold. Remember that annual municipal returns tend to range from 2.00% to 4.00%, so this would be significant on a relative basis.
Although returns are never guaranteed, if holiday seasonals persist for munis, Santa may just fill some stockings with positive returns.
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