Munis are the star performer of 2011

By Cate Long
December 16, 2011

Bloomberg had a great piece that rounds up the factors that made municipal bonds the best performing financial asset of the past year. The story is framed as a knock on Meredith Whitney for her scare call a year ago:

This was supposed to be the year the $3.7 trillion state and local debt market would be rocked by an exploding pension time bomb and “hundreds of billions of dollars” of defaults, according to analyst Meredith Whitney.

Whitney’s Armageddon never came. Instead, munis became the star performers of 2011.

An investor who bought $10,000 of munis the day after Whitney’s Dec. 19 prediction on CBS’s “60 Minutes” television program would have made about $1,050, based on the 10.5 percent gain in the Merrill Lynch Municipal Master Index, which calculates price changes and interest income. That beats U.S. Treasuries, stocks, corporate bonds and commodities. The muni return is better still because interest income is tax-exempt.

[...]

When returns are adjusted for price volatility, municipal bonds returned about three times more than corporate bonds and twice as much as Treasuries, according to Bank of America Merrill Lynch and Bloomberg data.

Bloomberg goes on to explain what happened this year in muniland that made municipal bonds such a stellar performer. Some of the factors were economic, some were fiscal, and some related to financial markets. As a time-saver I’m giving you the CliffsNotes:

  • Public debt benefited as Treasury yields plunged and investors fled volatile stocks
  • As the U.S. economy recovered from the longest contraction since the 1930s, fiscal revenues rebounded
  • State and local governments raised taxes
  • Many government entities addressed underfunded pensions
  • Practically all of muniland cut spending
  • Municipal bond borrowings were 30 percent less than 2010
  • Personal tax increases made the muni tax exemption more sought after
  • Municipal bond defaults continued at a low level of about $25 billion (~0.67% rate)

So, contrary to Meredith Whitney’s doomsday predictions, muniland did exceptionally well this year. Kudos must go to all state and local officials who got down to the hard work of right-sizing their budgets, bond issuance, and pension obligations. It is really tough to make the fundamental decisions about what areas of the budget will get resources. The U.S. Congress gets all the attention but it’s state and local governments who have done the heavy lifting this year.

Because muniland’s fiscal house is getting put into better shape, municipal bond issuance for 2012 is projected to increase slightly to $340 billion, which can easily be absorbed by financial markets.

The easy money in municipal bonds was made this year as investors bought bonds on the cheap after the Whitney scare and rode them to par. Those conditions won’t exist in 2012, but muniland should likely remain a preferred flight-to-quality venue for investors. It’s a quiet backwater of increasingly positive credit conditions.

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