Investing in individual municipal bonds can be a lot of work.
Avoiding landmines, like Detroit, takes a lot of research, due diligence and number crunching. And still, you’re exposed to the risk that rules will be bent (or completely made up on the fly) when things go wrong, as Rodney clearly shows above.
For many investors, buying a diversified municipal bond fund is a better option. A professional fund management team does all the tedious research and, since the fund will invest in many different municipal bonds of varying merit, diversification lessens the effect of one or two bad outcomes.
Still, investors must decide when it’s a good time to buy municipal bonds, in general, rather than other types of bonds, like U.S. Treasurys.
To answer that question, a ratio chart will help. Here’s a chart plotting the ratio of the iShares S&P National AMT-Free Muni Bd ETF (NYSE: MUB) to the iShares Barclays 7-10 Year Treasury ETF (NYSE: IEF). Take a look…
Municipal bonds have underperformed Treasurys since 2010, as the declining ratio above shows. Yet, the Fed’s tapering may work to reverse that trend.
I’ve highlighted in blue the period between May and October of last year, when the market was digesting the Fed’s plans to taper its bond purchases. As you can see, that period spurred a lot of volatility in the muni-to-Treasurys ratio, as investors tried to figure out what the future would hold.
Since then, though, the ratio has been rising. This suggests investors prefer munis in a post-taper world.
The ratio recently broke above an important trend line (drawn in red) and is close to making a higher high (dotted red line). Both would be strong indications of a trend change, where municipal bonds begin to outperform Treasurys.
It’s too early to make the call, but I’ll be watching this chart closely over the next few weeks.