In today’s low rate environment, many investors are looking for fixed income opportunities. As I’ve discussed in the past, for long-term investors, I favor corporate and municipal bonds over Treasuries.
Here are two reasons why I like corporate debt:
- Yield: Corporate bonds currently offer a rich yield relative to US Treasuries. Today, the spread between an index of Moody’s Baa-rated bonds and the 10-Year Treasury is 330 basis points, roughly twice the sixty-year average.
- Strong Balance Sheets: At the same time that corporate yields are high relative to Treasuries, corporate America’s balance sheet looks exceptionally strong. US companies are holding more than $2 trillion in cash, which represents roughly 7% of company assets and the highest level since 1963.
Here are also two reasons why I like munis.
- Yield: First, similar to corporate bonds, municipals currently provide a rich, after-tax yield versus Treasuries of a similar duration. An index of national long duration GO bonds is yielding roughly 3.8%. On a tax adjusted basis, that’s roughly equivalent to a 6% yield for a theoretical taxpayer in the 35% bracket.
- Unfounded Dire Predictions: Plus, while munis potentially offer investors a significant pickup in yield, I don’t believe investors in munis are taking on much more risk. As I’ve stated in the past, some of the more dire predictions for munis have turned out to be unfounded. Last December, we all heard predictions that 2011 would see hundreds of billions of dollars in defaults. Year-to-date, municipal defaults are running at less than $1 billion.
While both municipals and corporate bonds look cheap, by most accounts Treasuries look very expensive. While I hold a neutral view of Treasuries in the near term, I hold a negative longer-term view of Treasuries. Unless you believe that the United States is about to, or has already, entered a Japanese-style deflationary spiral, it is hard to justify accepting a 2% nominal yield and a negative after-inflation yield while taking on significant duration risk. (Potential iShares solutions: MUB and LQD).
Disclosure: Author is long MUB and LQD
Past performance does not guarantee future results.
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. An investment in the Fund(s) is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.