The Opportunity In Municipal-Backed Closed-End Funds: The Value In The 9th Inning Of The Great Bond Rally

July 21, 2015

by Michael Lebowitz

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“It is impossible to produce superior performance unless you do something different from the majority.” – John Templeton

For the last five years, bond market experts have unfailingly and wrongly predicted a rise in interest rates. If the current rate-hike fears prove unfounded again, municipal-backed closed-end funds (M-CEFs) is an asset subclass likely to perform well. Here are eight such funds to consider.

Before discussing those funds, let’s look at the trends driving the interest rate environment. In a 720 Global article from March 2015, “What deadly summers, Sandy Koufax and lucky golfers can tell us about bonds,” I concluded: “Deflationary forces around the globe are legion. Despite the battalion of seemingly gargantuan efforts by central bankers to prop up inflation and restart growth, those stated objectives remain elusively out of reach. Ignoring the truth of these circumstances will not diminish their impact on U.S. yields.”

That article proposed that a sluggish economy and ongoing deflationary pressures would continue to drive U.S. interest rates lower. Since then, yields (U.S. and German) have risen despite weaker economic activity and further deflationary signals. The Federal Reserve’s perceived stalling of rate increases, pronounced bond market illiquidity and bouts of foreign central bank selling were three of the chief justifications behind the recent increase in yields.

Since the great bull market in interest rates started in October 1981, we have seen numerous short-term counter-trend increases in rates. The result each time was curtailed lending, slower growth and a re-emergence of deflationary forces. Ironically, higher yields ultimately were followed by lower yields each time.

Despite the low absolute level of interest rates currently, the downtrend in yield is not over.

This current bond market sell-off has many of the markings of the so called “taper tantrum” sell-off in mid to late 2013. As in 2013, bond bears are declaring an end to a rally of over 30 years. In 2013 the bears believed the end of quantitative easing (QE3) would arrest the bull market in bond yields. In early 2014, despite QE3 ending and a distinctly bearish bond market tone, bond prices not only completely reversed the losses of the prior seven months, but went on to achieve new lows in yields.

Many factors suggest the current move higher in yield is a short-term retracement similar to the taper tantrum and other prior counter trend sell-offs. This instance will once again result in what technicians call a “lower low” in yields.

10 Year U.S. Treasury Yields (Long-Term Bull Market)

Municipal-Backed Closed-End Funds

Data Courtesy: Bloomberg

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