The municipal bond market is slowly coming out of a seasonal period known as the “summer doldrums,” often characterized by a decrease in new bond issues, as well as supply in the secondary market. As we emerge from this period, supply in both the new issue and secondary markets typically become more plentiful, resulting in widening credit spreads and higher yields.
This year, however, we are seeing changes to the seasonal patterns. A combination of factors, including domestic and geopolitical tensions that are not necessarily the seasonal norm, lackluster inflation numbers, poor wage growth and a Federal Reserve that appears to be accommodative in the face of such perils, are keeping more cash in the municipal bond market and very little supply in the secondary market. This is leaving spreads compressed and Treasury ratios at historical lows, especially inside of 10 years.
As a result, the primary market is presenting itself as the best place to fill the municipal security coffers at attractive prices. This is good news for retail advisors, who, in many cases, receive priority in such deals. Further, dealer “fast money” orders are typically stripped out of the retail order period, giving advisors a good chance of getting their clients’ orders filled, even before institutional account buyers. With that in mind, here are four strategies to consider in making the most of this season’s trends:
1. Have stock gains or municipal bonds you don’t like?
It is an appropriate time to start looking at tax loss swaps, rather than procrastinating until the end of the year. As mentioned, credit and structure spreads are tight as a result of a lack of secondary market supply. Tax loss swaps can be a good strategy to get out of poor credits and unwanted or underperforming structures. By divesting these structures, you may be able to redeploy assets into higher quality bonds, while minimizing spread penalty. You may also then offset the short-term/long-term gains with short-term/long-term stock loses, dollar for dollar. Make sure you consult a tax professional to ensure that you are not triggering the wash sale rule for your customer.
2. Have cash you want to put to work?
One trend that has remained consistent with typical seasonality this year is that the visible supply of new municipal bond issues is picking up as we begin to come out of the summer doldrums. This seasonal uptick in issuance presents an opportunity to buy new-issue product before the winter holidays, when new issues tend to dry up again. New issues are generally more attractively priced than those offered in the secondary market this time of year, with much greater availability along the maturity schedule. As such, advisors can more easily choose the right maturities for their clients. In addition, if an advisor is putting in orders during a retail order period, he or she receives priority over institutional orders. That can make a big difference in gaining valuable access to a broader selection of bonds at attractive prices.
3. Buying in the secondary market? Always show a bid.
I can’t stress this enough. When buying bonds in the secondary market, do your research. Look at the trade history with a critical eye to see how long a bond has been in dealer hands and how actively it has been trading before you buy. Many offerings have been stagnant on the Street all summer (in some cases longer!) and traders have those positions at the top of their “need to move” list, which makes them more amenable to price negotiation. Herein lies an opportunity to obtain better prices for you and your clients than those prices listed on the screens. The best way to capitalize on this trend is to execute your trades on the best negotiation platform possible to ensure that you buy your bonds at the right price. This can make a meaningful difference for you and your clients.
4. Need to raise cash?
Active secondary buyers and traders tend to be starving for “new muni credits” during this time of year. This is often the result of the lack of secondary supply, as well as the inability of these buyers and traders to take down the more attractive new issue market. They’ll often pay a higher price for bonds coming out of customer accounts that haven’t been sitting around in the dealer market (the Street) all summer. As such, this may be a valuable time to clean house in some of your portfolios. Consider selling those positions you are least excited about to meet cash needs. After all, poor credit and structure penalties are more forgiving during these low secondary supply periods in our market.
Municipal Bond Risks
As with all investing, investing in municipal bonds carries certain risks. Beyond the usual risks associated with fixed income, such as interest rate, reinvestment and default risk, investing in munis has some unique risks as well. One such risk is legislative risk. One appealing aspect of munis is their tax-exempt status at the state and federal levels. However, the risk is that changes in the tax code and other legislation may change that treatment during the time you hold that bond. Additionally, munis can face more secondary market liquidity challenges than their corporate debt counterparts due to the smaller issuer sizes and less debt outstanding. Because of these risks, it is important to always read and understand the Official Statement and any Continuing Disclosure Notices before making an investment decision.
 IRC 26 CFR 1.1091-1: Losses from wash sales of stock or securities