Call #1: Maintain Overweight US Municipals

This week, our first call focuses on our preference for US Municipals over Treasuries

We first highlighted the opportunities in munis back in late November. So far, year-to-date, the iShares S&P National AMT-Free Municipal Bond Fund (MUB) is up around 6%, outperforming Treasuries as well as investment grade and high yield bonds. Past performance does not guarantee future results.  For standardized MUB performance, please click here.

While we continue to maintain a view that investors should overweight equities over bonds, within the fixed-income space we continue to advocate overweighting national munis. First, as we have argued in the past, while the states certainly have their own fiscal challenges, revenues are improving. By and large, the term structure for most municipalities – in other words the timing of their funding needs – also looks better than that for the federal government.

Second, even after their recent outperformance, munis still appear cheap relative to Treasuries.  The average 10 year general obligation (GO) municipal bond is currently trading at about a 110 basis point premium to a comparable Treasury. Historically, due to the tax advantage of munis, a 10 year GO bond would typically trade at about a 70 bps discount. And again, this discount looks even more compelling when you consider the amount of supply the US Treasury needs to sell over the coming year due to chronic deficits.

In addition, currently, the yield to maturity on MUB is around 3.3% with an average maturity of less than 8 years.  For additional MUB yield information, please click here.

Bottom line – we would continue to hold an overweight view of US Municipals and to support funding it through an underweight view of long-term US Treasuries (potential iShares solution: MUB).

Call #2: Maintain Overweight Russia

Our attention next turns toward providing an update on our short-term tactical overweight view of Russia. We first made this call in early April. Since then, the iShares MSCI Russia Capped Index Fund (ERUS) is down around 8% versus a 5% loss for a broader emerging market index. Past performance does not guarantee future results.  For standardized ERUS  performance, please click here. Despite the underperformance, we continue to like Russia as a tactical play.

The country is obviously not without its share of issues, but we believe these are already priced into the market. Russia trades 5.5 times next year’s earnings, making it cheaper than Pakistan. And while corporate governance is an ongoing issue, companies in the main MICEX Index are producing a healthy 20% return on earnings. Finally, it is worth noting that in this season, when many countries – from Greece to the United States – are struggling with too much debt, Russia has one of the smallest sovereign debt burdens in the world, at less than 10% of GDP.

In short, we recognize that there are significant risks associated with Russia, and obviously Russia would not be suitable for more conservative investors. But for more tactically minded investors, we believe that the challenges facing Russia are more than adequately discounted in the valuations, and as such the country represents an interesting opportunity (possible iShares solution: ERUS).

Source: Bloomberg

Bonds and bond funds will decrease in value as interest rates rise. A portion of a municipal bond fund’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains, if any, are subject to capital gains tax. Federal or state changes in income or alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments and securities focusing on a single country may be subject to higher volatility.