The municipal market offers solid fundamentals and the most compelling value since 2011, following last month's historic selloff, BlackRock Inc. said in its July municipal report.
The market will continue to be bolstered by strong demand during the July and August reinvestment period, which should bring an estimated $75 billion in coupons, calls, and maturities, in addition to continued demand from crossover buyers lured by municipals' relative attractiveness, Blackrock said.
"Although painful, and some might argue overdone, the selloff was healthy in that it restored value in the market," Peter Hayes, managing director and head of the municipal bond group and James Schwartz, managing director and head of municipal bond research, wrote in the monthly report.
"After underperforming Treasuries in recent weeks, muni-to-Treasury ratios are above 100% across all maturities," they wrote.
The correction was not credit-driven or muni-specific, but rather a "rates-driven event" precipitated by a June 19 announcement where Federal Reserve Chairman Ben Bernanke hinted at the eventual end to quantitative easing, the analysts said.
"Fed talk of tapering its bond purchase program sent all markets into a 'taper tantrum' whereby stock prices dropped and bond yields rose," they wrote.
The market rallied on June 25, but not before yields soared almost 60 basis points over the three preceding trading sessions to levels not seen since 2011, in the worst three-day selloff in a quarter century.
"Munis underperformed their Treasury counterparts in the melee as the supply/demand backdrop weakened," the report said.
While June is usually the heaviest issuance month, with five and 10-year averages in the area of $41 billion, and 2012 at $43 billion, this year supply dropped to $23 billion in the month, according to the report.
"This was well below expectations and historic norms, but still too much for the eroded demand base," judging by the negative $16.5 billion of monthly fund flows, the analysts wrote.
"This was significant, but not entirely unexpected," they said. "The voracious demand of the prior two years could not continue unabated, much like the stellar performance run. Some would argue a correction was overdue."
The S&P Municipal Bond Index returned -3.02% in June, according to the analysts, who called it "the worst monthly showing since September 2008" when the index returned -4.83% amid the credit crisis.
"Ultimately, the correction restored value in the market, particularly relative to Treasuries, a fact that is already drawing the interest of crossover buyers," the analysts added.
The firm itself is keeping its duration neutral and focusing on the intermediate slope of the yield curve. It is currently "overweight" in state tax-backed and essential service bonds, particularly in the Southwest, Plains, and Southeast regions; as well as lien-status bonds, such as California school districts; and dedicated tax bonds, meaning it holds more of these securities than are in a benchmark portfolio. It is underweight in land-secured, senior-living, pre-refunded bonds, and student loan paper, as well as local tax-backed issues, particularly in Alabama, Nevada, Arizona, Michigan, Illinois, Rhode Island, and Puerto Rico.
"Overall, tax-exempt munis remain an attractive option for income-oriented investors seeking to keep more of what they earn," the analysts said.
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