Recommendation: Keep municipal bonds in mind

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While no longer cheap per se after their extraordinary run in 2014, municipal bonds continue to look attractive versus both Treasuries and corporate bonds. For instance, yields for longer-maturity munis rival or exceed those of their taxable counterparts on a before-tax basis, and this only increases the after-tax value.

Muni bonds YTD returns

Market Realist – The graph above shows the year-to-date, or YTD, returns offered by various segments of the fixed income market, as measured by Barclays indices. U.S. corporate high yield bonds (HYG)(JNK) have given returns of 3.25% YTD. U.S. Treasuries (TLT) have given 4.14%. U.S. Aggregate (AGG)(BND) have given 5.14%. And Treasury inflation-protected securities (TIP) have given 5.19%. Municipal bonds (MUB) have outperformed all other segments, with returns of 8.44% YTD.

Municipal bonds have given nine consecutive positive months up to September 2014. According to BlackRock estimates, muni bonds are currently exhibiting their fourth-strongest price performance in over 20 years.

Market Realist – The graph above shows the yield curves at the end of August and September for both AAA municipal bonds and U.S. Treasuries (TLT). Both have moved upwards from the previous month. Muni bonds are benefiting primarily due to the following factors:

1. Supply is less than demand for muni bonds. In September, $22 billion worth of muni bonds were issued. This is 20% less than the ten-year average and 10% less than the five-year average.

2. Geopolitical turmoil is causing a flight to quality, causing investors to invest in the asset class.

3. The low-rate, high-tax environment makes municipal bonds a better investment opportunity than U.S. Treasuries.

Municipal bonds are offering higher returns and tax benefits. This makes muni bonds a good investment strategy.

Read on to the next part of this series to see why you need to go beyond traditional stocks and bonds this quarter.

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