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Home > Investing > Muni Bonds: Good Value or Value Trap?

Muni Bonds: Good Value or Value Trap?

December 30th, 2010 Leave a comment Go to comments

It’s been a roller coaster ride for bonds. Since the 2008 Great Recession, we’ve seen Treasury bonds all over the place in pricing. The most recent move to lower prices has been abrupt and significant. The 10-year note has gone from about 2.5% yield to over 3.3% yield (lower bond prices mean higher yields).

For Municipal bonds however, the story is somewhat different. Like most assets classes, they bottomed in 2009, caught a bid towards recovery and stabilized to prices that were lower than pre-recession prices but stable nonetheless.

Until the last couple of months. Prices have weakened, and yields have gone up. What to make of all of this?

Muni Value Trap?

Value or income investor know all too well about value traps. You see, when the price of an investment decreases its income yield goes up making the investment more attractive from an income point of view. Sometimes, the investment drops in price further wiping out any benefit from the higher yield. This could be for a number of reasons, but in the end the yield was a trap.

Sometimes the market is signaling that the earnings are suspect or unsustainable. Or, the market may be adjusting the multiple offered on the investment perhaps because future earnings are expected to be much lower than expected. Or, it simply could be a market mis-pricing which can occur too.

A real disaster occurs when your investment value drops and the investment lowers its income. You lose both ways. As anyone who invested in large bank stocks say 5 years ago, you lost almost all of your income and much of your capital.

Are muni’s a value trap? Most likely not, if you believe that most of these bonds, especially the higher credit quality ones, will continue to pay.

Why Buy Now?

When buying any asset, the best time to buy is when the uncertainty is highest and your confidence in the long term soundness of the investment is confirmed. It’s difficult to get the bottom, so the best strategy is to buy in smaller chunks overtime. When many other asset classes have been rising, one of the last asset classes that has faltered has been muni bonds.

For Municipal bonds, even though there is credit risk here, the reality is that the vast majority of these bonds will continue to pay, even ones of lower credit quality. If stick with bonds that are higher credit quality, you will buy an investment that offers tax free income at an attractive price with an opportunity for capital gains as well.

If they continue to pay income over time, the likely scenario is that the bonds will recover as the economy recovers.

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