Total issuance of new municipal bonds may set a record in 2010, but the real story for investors is the composition of new bond issuance. Wall Street forecasts range from $415 billion to $450 billion in new municipal bond issuance for 2010, with most forecasts clustered towards the upper end of that range.

photo credit: whittlz

New municipal bond issuance in 2010 therefore stands a chance to break the 2007 new issue record of $435 billion. Supply is one of the most important drivers of municipal bond performance and manageable supply helped produce good performance in 2009.

What’s the Issue?

Issuance of new bonds is important since it can have a notable impact on the supply-demand dynamics that influence bond pricing and yields. New issuance is more important in the bond market, relative to equity markets, since bonds have maturity dates and new issuance is a more constant factor in the market. Furthermore, bonds (with few exceptions) are not listed on exchanges and trading is over-the-counter, making it more sensitive to supply-demand variations.

However, what matters for most municipal bond investors is the dollar amount of traditional tax exempt issuance. Prior to 2009, taxable municipal bond issuance averaged 5% of total municipal bond issuance. In 2009, taxable municipal bond issuance amounted to 20% of all municipal bond issuance thanks to the Build America Bond (BAB) program. BAB issuance may exceed $100 billion in 2010 and may reach as much as $140 billion according to some estimates. Subtracting $100 to $140 billion from the $450 billion high estimate for 2010 overall municipal issuance leaves a $310 billion to $350 billion range for traditional tax exempt issuance. This level is roughly in line with the $325 billion in 2009 tax-exempt issuance. If tax-exempt issuance reaches $350 billion in 2010 it would still be the lowest level since 2004.

Therefore the traditional tax-exempt bond market is expected to see little, if any, growth in 2010 at a time when demand is expected to remain high. A number of states have already increased tax rates for 2010 with more likely to follow. At the national level, the top tax rate is set to revert back to 39.6% from the current 35% at the end of 2010. In addition, demographics reflect a growing investor base for tax-exempt income.

Build American Bond Program

photo credit: jcookfisher

The BAB program is widely expected to be extended beyond its current year-end 2010 expiration but additional expansion of the BAB program could result in even fewer tax-exempt bonds. Lawmakers are currently deciding whether to allow BAB new issuance be used to refinance existing tax-exempt bonds. Should such a provision be added, BAB issuance could increase further and reduce the supply of traditional tax-free bonds further.

BAB bond issuance has been well received in the market. BABs offer slightly higher yields than comparably rated corporate bonds. Although the yield differential is not as wide as when BABs initially launched in April 2009, the differential still is attractive to taxable bond investors, foreign buyers in particular, looking to diversify existing corporate bond holdings.

BABs issuance has a greater impact on the longer-term portion of the municipal bond market. BABs are issued for infrastructure and other longer term projects which require longer maturity bonds. Additionally, since long-term municipal bonds, rather than short-term bonds, are more cheaply valued to Treasuries, longer-term BAB issuance is more economically advantageous for states and municipalities. Roughly 95% of BABs have maturities of 10-years or greater. As a result, the supply impact, or lack of it, will more greatly impact longer-term municipal bonds. This is another reason why we continue to favor intermediate and longer-term maturity municipal bonds. As mentioned in our 2010 Outlook, the BAB issuance dynamic is a key reason why we believe longer-term municipals should prove resilient to the prospect of rising interest rates.

New issuance is of particular importance in the municipal bond market since it is more sensitive to changes to supply-demand dynamics compared to the taxable market. Individual investors, either directly via individual bonds or indirectly via mutual funds, comprise the vast majority of the market. If new municipal issuance leads to a sudden increase in supply at a time when individual investor demand is relatively weak, lower bond prices and higher yields may follow. Conversely, when demand is firm and new issuance is relatively light or non-existent, bond prices may rise as a result.

What About Taxable Bonds?

The taxable market, on the other hand, is dominated by institutional investors who are mandated to be fully invested and stay close to targeted investment benchmarks. Institutional investors tend to be more broadly diversified and are constantly reinvesting maturing bonds back into new bonds. This creates more steady demand regardless of conditions and makes the taxable market less sensitive to individual investors whose buying interest is much influenced by the level of interest rates rather than a particular benchmark or allocation.

This dynamic is a key reason why the municipal market has historically proven to be less sensitive to rising interest rates. Conversely, the municipal market has often lagged the movement in Treasury yields when interest rates decline.

As the New Year begins, municipal bond investors will see headlines for a potential record year of municipal bond issuance. However, the issuance of traditional tax-exempt bonds will be near the lowest levels of the past several years. Reduced tax-free bond supply as a result of BAB issuance and potential expansion, coupled with rising tax rates and a growing investor base, indicate the favorable supply-demand balance that benefited municipal bonds in 2009 will continue in 2010. We continue to favor intermediate and longer-term municipal bonds where valuations and supply issues provide a more favorable backdrop.

IMPORTANT DISCLOSURES

• This was prepared by LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
• The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest
• rates rise and are subject to availability and change in price.
• High yield/junk bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
• International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
• Stock investing involves risk including loss of principal.
• Investing in mutual funds involve risk, including possible loss of principal. Investments in specialized industry sectors have additional risks, which are outlines in the prospectus.

photo credit: rohank9

Top rated tax-free municipal bond yields did not quite match the decline in Treasury yields in August, but performance was impressive nonetheless and followed a strong month of July.

The favorable supply/demand balance that has aided municipal bonds all year became acute in August. Investor demand intensified while supply decreased further. Investor flows into municipal bond mutual funds continued at a frenetic pace. Through August 26, municipal inflows totaled $46 billion according to AMG data services, more than the full year record of $44 billion recorded in 1993. The supply/demand balance helped push year to-date performance of the Barclays Municipal Bond Index just over 10%.

At the same time, Municipal supply decreased further in August with new issuance 27% behind last year’s pace according to Bloomberg. In August the low supply situation was exacerbated by taxable Build America Bonds (BABs) representing one-third of monthly issuance, the highest percentage of monthly issuance since the BABs program was launched in April of this year and higher than an average of 10% to 20% per month. This left traditional tax-exempt bond investors fewer bonds to pick from at a time when demand remained robust. This powerful one-two combination translated into strong municipal performance.

Investor demand for yield…..

caused long-term bonds and lower rated bonds to outperform in August. Long-term bonds benefited from a municipal yield curve that remains at historically steep levels. The yield curve slope, as measured by the yield difference between 2-year and 30-year AAA-rated municipal bonds, remains very near a record wide level. In contrast, the 2-year to 30-year Treasury yield gap of 3.3%, while also wide, is below its 3.6% peak. In other words, municipal investors get compensated more for extending maturity compared to taxable investors.

Record low short-term yields have also pushed investors out further onto the yield curve. The SIFMA 7-day Yield, an average yield on municipal variable rate demand notes, the primary security type in money market funds, has dropped to a new record low and brought money market yields to mere basis points. In response investors have extended maturity to short-term bonds. With one to five-year municipal bonds now expensive and the Federal Reserve stressing an “on hold” message, investors have extended further.

The reach for yield benefited high yield bonds which returned over 3% according to the Barclays High Yield Municipal Index. Within the high yield market, the riskier Tobacco Bond sector outperformed with the average yield declining a staggering 2% in just one month. The grab for yield is also reflected in long-term California St. GO bonds where average yields are 1% lower just two months after being punished on bankruptcy fears. Despite the improvement, yield differentials between top quality municipals and lower rated issues remain relatively wide.

Supply is light to start September which bodes well for the municipal market to hold recent gains. However, recent strength has exceeded our expectations and an expected pick up in new issuance in late September/early October could lead to modest weakness. The state of California is expected to issue $10 billion in short-term notes late in the month and while sentiment has become more positive on California, that is a significant amount of debt for the municipal market to digest.

Lower absolute yield levels…..

may also cause investors to balk or hesitate on new purchases. We view this as simply leading to a more gradual pace of improvement going forward. Although short-term municipal valuations have become expensive in our view, intermediate to long-term municipals are still attractive relative to Treasuries. Thanks to the greater decline in Treasury yields, municipal valuations actually cheapened in August.

We would use weakness to add to municipal positions as we remain positive on municipals over the longer-term. Several factors support our long-term positive view. Supply should remain light as BAB issuance will continue to take away supply originally intended for the traditional tax-exempt market. President Obama has even proposed extending the BAB program beyond its current year end 2010 sunset date. If extended, the supply dynamic could be positive for longer.

Most importantly, higher future tax rates continue to bode well for municipal valuations. Municipal investors are becoming increasingly aware of this and this factor likely played a role in recent demand. According to Bloomberg,13 states have or are in the process of increasing local taxes. In late August, the Governor of Connecticut was the latest to make headlines and proposed increasing taxes on individuals earning over $500,000 and couples earning more than $1 million. Keep in mind the Bush tax cuts expire at the end of 2010. While some tax rates will be maintained a return to an effective top bracket of 39.6% (or higher) from 35% is highly likely in our view.

Municipal bond performance has been impressive over the summer. While low supply bodes well as we start September, we would not be surprised to see some weakness on a pick up in supply or investors slowing purchases based on now lower yields. However, key factors that have driven year-to-date performance remain in place. We would view any municipal weakness as an opportunity to buy as we still find the sector attractive over the longer-term.

IMPORTANT DISCLOSURES

• The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Neither LPL Financial nor any of its affiliates make a market in the investment being discussed nor does LPL Financial or its affiliates or its officers have a financial interest in any securities of the issuer whose investment is being recommended neither LPL Financial nor its affiliates have managed or co-managed a public offering of any securities of the issuer in the past 12 months.
• Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
• The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
• High Yield/Junk Bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
• GNMA’s are guaranteed by the U.S. government as to the timely principal and interest, however this guarantee does not apply to the yield, nor does it protect against loss of principal if the bonds are sold prior to the payment of all underlying mortgages.
• Muni Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and state and local taxes may apply.
• Stock investing involves risk including loss of principal.

This report was prepared by my firm LPL Financial.

photo credit: scraggy & fluffy

Bond investors have always worried about the impact of rising interest rates on their portfolios and rightly so. So, higher yields in the market translate to lower prices for existing holdings and investor worries about rising interest rates. Their worries have increased over the second quarter of 2009. As we
approach the midpoint of the year, many investors are no doubt concerned over the rise in the benchmark 10-year Treasury note yield from 2.2% to 3.5% (through June 29). Worries over higher yields (lower prices) and potential losses may resurface as investors look to the second half of 2009
and beyond.

• While Treasury yields have increased, yields in other key segments of the bond market are actually lower now than at the start of 2009.
• When considering the impact of rising interest rates, investors need to assess the time period over which that increase occurs.
• We believe there is enough of a buffer against higher interest rates in non-government bonds for the broad bond market to produce mid-single digit returns for the full year.

Despite the rise in 10-year Treasury yield, the average corporate bond yield is actually lower now than at the start of the year. The yield on the Barclays Capital Corporate Index stood at 6.0% as of June 25, down from 7.5% at the end of 2008. Corporate bonds benefited from improving liquidity and investors taking advantage of cheap valuations, while Treasuries faced high valuations with massive new issuance.

Municipal Bonds Lower

Similarly, Municipal bond yields are lower in 2009. The average yield on 10-year AAA-rated Municipal bonds declined while the 10-year Treasury yield increased. Like Corporate bonds, Municipals benefited from better liquidity and investors taking advantage of cheap valuations.

While the performance above seems counter intuitive, it highlights the importance of sector allocation in the bond market and the fact that higher Treasury yields (lower Treasury prices) don’t necessarily translate into higher yields (lower prices) across the entire bond market.

The most striking yield disparity is in the high yield market, where the average yield declined from 21.0% to 12.7%. Historically, High Yield bonds, more sensitive to changes in the underlying economy, have often diverted from higher quality bonds and been able to withstand higher Treasury yields.   We believe the yield disparity will slow but not completely disappear over the second half of 2009, as we discuss later.

Timing

When considering the impact of rising interest rates on your bond portfolio,timing plays a crucial role. Over short periods of time, higher interest rates translate into lower bond prices—interest income is unable to soften the blow in terms of total return. Over longer periods of time, interest income is the main driver of bond performance and can be a powerful force. The impact of higher interest rates can be offset by interest income. This is one reason why the bond market still managed positive total returns in the late 1970s and early 1980s despite a rise to double-digit interest rates.

As an example, using the current 5-year Treasury note, a 0.50% rise in 5-year interest rates would result in a 4.4% loss from June 29 to September 30, 2009, a 3-month holding period. However, if holding for one-year, the bond actually would produce a positive total return of 2.3%, as interest income would offset the price decline associated with higher interest rates.

When the gap between shorter-term and longer-term yields is relatively wide, the yield curve is considered “steep” and it also provides downside protection. Yields are generally lower for short-term maturities, reflecting lower interest rate risk. However, as a bond moves closer to maturity, it benefits from “rolling down” into a lower-yielding segment, which provides price support as a bond approaches maturity, even if interest rates rise. Interest income is a potentially greater buffer for non-Treasury securities when yields are higher. According to Bloomberg, the average A-rated, 5-year maturity Corporate bond yield was 2.7% above Treasuries (as of June 29,2009), a signifi cant income advantage. For an investor looking to guard against higher market interest rates that might result from an improving economy, the added income might be more than sufficient to compensate for the credit quality differential, since Treasuries are AAA-rated. This is our bias and one reason we continue to favor Corporate bonds. The income
advantage between A-rated Corporate bonds and Treasuries has declined but still remains above the prior peak in 2002.

In the municipal market, long-term Municipal bond yields are still above comparable Treasury yields, which suggest the divergence witnessed so far this year may continue. The average AAA-rated 30-year Municipal bond yield of 5.16% (as of June 29) is 120% of the 4.29% yield on the current 30-year Treasury bond. Prior to the start of the credit crunch in July 2007, this Municipal/Treasury yield ratio was 92%. If this relationship were to return to pre-crisis levels, the 30-year Treasury yield could hypothetically rise to 5.61% (taking the 5.16% Municipal bond yield and divide by 0.92), while Municipal bond yields and prices remain unchanged. While we don’t believe it play out exactly this way, it shows how Municipal bonds could withstand higher Treasury yields.

Risks of Relying on Interest Income

One of the risks to relying on interest income is that absolute yields, on balance, remain low by historical comparison, definitely true for government bonds but less so for Corporate bonds. The beneficial impact of interest income is therefore reduced, but not enough to offset our expectation of mid-single digit returns for the bond market in 2009.

Gradual Improvement over the Remainder of Year

The divergence between the direction of Treasury yields versus Corporate and Municipal bonds over the first half of 2009 has been impressive. We expect this trend to persist but also anticipate it will be more gradual over the second half of 2009. The yield disparity between Treasuries and non-Treasury sectors such as Municipal and Corporate bonds still remains wide and may offset the impact of higher Treasury yields.

Over a longer-term horizon we do expect higher interest rates/higher bond yields, but believe that outcome will require an acceleration of inflation and/or Federal Reserve interest rate hikes. We see neither as likely over the second half of 2009 or the beginning of 2010. Until then, upward pressure on interest rates will be offset by interest income. As a result, we remain focused on intermediate bonds that benefit from a steep yield curve and sector allocation where yield differentials are still wide. We believe it is too early to take a defensive posture in short-term bonds.

IMPORTANT DISCLOSURES

• The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Neither LPL Financial nor any of its affiliates make a market in the investment being discussed nor does LPL Financial or its affiliates or its officers have a financial interest in any securities of the issuer whose investment is being recommended neither LPL Financial nor its affiliates have managed or co-managed a public offering of any securities of the issuer in the past 12 months.
• Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
• The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
• High Yield/Junk Bonds are not investment grade securities, involve substantial risks and generally should be part of the diversifi ed portfolio of sophisticated investors.
• GNMA’s are guaranteed by the U.S. government as to the timely principal and interest, however this guarantee does not apply to the yield, nor does it protect against loss of principal if the bonds are sold prior to the payment of all underlying mortgages.
• Muni Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and state and local taxes may apply.

Is now the time to buy Muni bonds?

This report was prepared by my firm LPL Financial

The municipal market may soon garner negative headlines if an expected large number of states and municipalities announce budget deficits with the July 1 start of their fiscal year. Municipal bond credit quality may therefore come under question, and investors need to be prepared. Budget strains were expected but are becoming more widespread, and none are more high profile than California’s. Last week, State of California general obligation bonds were placed on credit watch for a potential downgrade by all three major rating agencies, citing the lack of a budget resolution.

• Although news of budget strains may peak over the coming weeks, municipal credit quality questions will likely persist for some time.
• However, the municipal market has historically held up well in response to credit quality challenges.
• Municipal bond investors can take preventative measures but should stay the course and use weakness to add to positions.

The Rockefeller Institute of Government, an independent researcher of state and local governments, reported June 18 that states’ personal income tax collections declined by 26 percent during January to April of 2009 versus the same period in 2008. Among the three sources of state revenues, personal income tax, corporate income tax, and sales tax, personal taxes are typically the biggest share of state revenues. Although states and municipalities do their best to forecast revenue shortfalls, mismatches can occur with budget shortfalls as a result.

Municipal Bond Investors Should Be Cautious

Municipal investors should be aware that budget issues will likely persist for some time due to the lagged way recessions impact state and local budgets. The highest income taxpayers, who contribute most to personal income tax revenue, often derive a substantial portion of their income from capital gains  in the stock market. These high-income taxpayers generally make estimated tax payments on a quarterly basis based on the prior year’s tax liability, which is usually determined by April of the current year. So early 2009 payments were based on 2008’s tax liability, and future payments are likely to be ratcheted down as lower income and capital gains are reflected in even lower payments through the remainder of 2009 and into 2010.

State revenues have bottomed on average two years after the start of recession. Since the recession started in 2008, this history suggests state and municipal revenues will continue to be impacted into 2010. According to the Washington D.C. based Center of Budget and Policy Priorities, state budget deficits may collectively accumulate to $370 billion by fiscal year 2010-2011. Fiscal stimulus, which totals $140 billion over three years, is a huge aid but still addresses less than half of states’ needs.

States have already taken steps, with 23 already increasing taxes or fees, and another 13 planning to do so, in addition to cutting expenses: the two traditional steps to balancing budgets. The process can unfortunately be subject to political wrangling, with one side clamoring for higher tax rates and the other for cost cutting. Both views can create negative headlines as politicians stress the negative consequences of each and often wait to the last hour before settling budgets. In the meantime, the resulting uncertainty can lead to weak markets.

However, the municipal market has historically held up well in response to credit quality challenges. We believe that budget strains will result primarily in downgrades and that defaults will be more isolated. Should conditions deteriorate further, however, it is worth noting how well the municipal market has historically withstood such tough times.

photo credit: luipermom

Municipal Bonds Resilient

During the Great Depression the default rate increased to 7%, according to a report from the National Bureau of Economic Research (NBER); however, the default rate ultimately amounted to only a 0.5% loss rate for investors as municipalities paid most debt obligations back at full value within 18 months. Hurricane Katrina posed another recent threat as the population of New Orleans fell by almost 50 percent in the year following the hurricane. Despite this reduced tax base, no New Orleans general obligation bond (GO), nor any of the area’s various school district GO bonds, defaulted. Many bonds were downgraded to below investment grade but returned to investment grade status within two years.

The resiliency of municipal bonds was highlighted in a 2007 report by Moody’s Investors Service, which states the 10-year cumulative default rate from 1970 to 2006 for all investment grade municipals averaged only 0.10%. The default rate for bonds rated single-A was 0.03%, less than that of triple-A rated corporate bonds. For those that did default, recovery rates were very high at 90 to 95 cents on the dollar for non-healthcare related bonds. Moody’s was set to upgrade thousands of municipal bonds based on the findings of the report but has postponed such a move due to the recession.

Part of the resiliency of the municipal market can be attributed to the  flexibility of issuers, unlike corporate issuers. Many municipalities are monopolies and have great latitude in raising income (by increasing taxes in some cases) and cutting expenses. In the event of default, municipalities cannot simply vanish the way a corporation such as Circuit City might. The municipality and its service obligations to its residents remain, and the municipality is forced to restructure. Since most will have to tap debt markets in the future, treating bondholders as best as is possible is in the municipality’s best interests in order to borrow at an economically feasible rate in the future. In 1994, Orange County, California, the largest municipal bankruptcy on record, was an example of this as all debt obligations, including payments to other municipalities, were paid in full.

What investors can do

It is quite possible that the municipal default rate could surpass that of the Great Depression. Today’s municipal market is different, with more complex bonds which include special purpose financing and corporate backed bonds.

How do investors prepare? First and foremost, investors can stay with high quality bonds rated single-A or higher. This segment of the market has demonstrated minute default rates. Furthermore, by focusing on general obligation and essential service revenue bonds, investors take additional precautionary steps. In California, for example, a bond backed by a water revenue project is likely to retain pricing power and weather the recession better, because water is a scarce commodity in the state. The Moody’s report referenced earlier also highlights a well-known fact in municipal markets;
defaults have been concentrated among healthcare, multi-family housing, and corporate-backed bonds (such as Industrial Development Revenue bonds).

With regard to current markets, municipal bonds are living up to history. The vast majority of defaults so far over 2008 and 2009 have been among low rated (either below investment grade or non-rated) issuers and bonds from housing, healthcare, or corporate backed sectors. The municipal market is already priced for credit deterioration. Although yield differentials, or the spread, between top rated bonds (AAA) and the lowest investment grade rated bonds (BBB) have narrowed over the past few months, they are still almost double the prior peak. A wide yields spread is one reason why we maintain an allocation to Tax-Free High Yield Bonds.

The high quality municipal market has improved a great deal relative to Treasuries in 2009 but remains attractively priced. By simply comparing average AAA-rated municipal yields as a percentage of Treasury yields, we note that average 30-year AAA municipal yields are 117% of comparable Treasuries (i.e., still higher than Treasuries), versus 90% before the credit crunch began in July 2007. The higher this percentage, the cheaper municipal bonds are relative to Treasuries and vice versa. Similarly, average AAA-rated municipal yields are 93% of Treasuries, versus 80% pre-credit crunch.

We do not dismiss credit concerns, as they will be with the municipal market for some time. In our 2009 Outlook Base Case Scenario, we expected municipal valuations to remain cheap to historical norms, and credit quality was one of the reasons why. Credit quality concerns could lead to bouts of weakness. More risk adverse investors can take additional precautions by focusing on higher rated or safer sector issues. Still, we think the market has priced in a buffer via cheap valuations to Treasuries and still wide yield spreads. Given improvements in the national economy over the second quarter, the tide is slowly turning. We would use bouts of weakness to add to municipal positions. Over time, states and municipalities will repair their balance sheets, and the prospect of higher future taxes makes today’s valuations compelling.

IMPORTANT DISCLOSURES

• The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Neither LPL Financial nor any of its affiliates make a market in the investment being discussed nor does LPL Financial or its affiliates or its officers have a financial interest in any securities of the issuer whose investment is being recommended neither LPL Financial nor its affiliates have managed or co-managed a public offering of any securities of the issuer in the past 12 months.
• Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of funds shares is not guaranteed and will fluctuate. The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
• High Yield/Junk Bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
• GNMA’s are guaranteed by the U.S. government as to the timely principal and interest, however this guarantee does not apply to the yield, nor does it protect against loss of principal if the bonds are sold prior to the payment of all underlying mortgages.
• Muni Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and state and local taxes may apply.