Certain events have occurred during the past several weeks to push tax-exempt yields higher, creating attractive situations in the municipal bond market.
For one thing, the yields on taxable U.S. Treasuries rose as that sector of the market saw the 30-year T bond increase to 7.72 percent and intermediate rates increase to 8.00 percent before declining again. Further, it is possible that the tax revision bill sponsored by Sen. Bob Packwood (R-Ore.), which would lower marginal tax rates significantly, will be passed.
Finally, the huge calendar of new municipal issues arrived in the market right when these factors were creating a great deal of uncertainty. The 5-day moving average of the 30-Day Visible Supply of new municipal issues has been bouncing between $4.4 billion and $6.5 billion since mid-April. And, since late April, the dealers' offerings of unsold merchandise, as shown in the Blue List, has topped $2.2 billion. Both numbers taken together -- especially in a less-than-exuberant market -- spell trouble.
But from trouble and confusion come investment opportunities.
Because of this huge supply of high-grade issues rated AA and AAA, the yields on this type of paper have increased more than the yields on the lower-grade A-rated paper, especially revenue issues. As a result, the yield spreads between low-grade issues and high-grade issues are at their narrowest point in the past year.
Currently, the yield spread between 20-year AAA-rated general obligation issues and 20-year A-rated electric-revenue issues is 40 basis points. A basis point is one one-hundredth of a point.
During the past year, that spread has averaged 85 basis points, and has been as wide as 125 basis points. From the standpoint of investment strategy, it means that the owners of lower quality (A-rated) paper now can trade into the highest quality paper with a minimum give-up of yield, 40 basis points. Further, at a later date, if the investor so desires, when those spreads widen out once again, say to 100 to 125 basis points, the investor could reverse the trade, selling the AAA issue and purchasing another A-rated electric revenue with a pickup of 100 to 125 basis points in yield. Overall, on the round trip, from the revenue to the AAA and back to the revenue, the investor would show a net increase in yield of anywhere from 60 to 85 basis points (100-40 and 125-40).
Currently, the yield on a 30-year A-rated electric-revenue bond is 106.7 percent of the yield on the taxable 30-year T bond (8.02 percent 7.51 percent). For whatever reasons, this is the largest advantage in favor of the electric-utility yields over the Treasury yields in the past year. On this basis alone, long electric-utility bonds are very attractive.
The Treasury will offer a 5-year note on Wednesday in minimums of $1,000. They should return 7.65 percent.