Philip G. Condon knows his history.
And if history is any guide, the 30-year veteran of the municipal bond industry says, the single-A rated, 30-year muni is the sweet spot of the market today.
Condon, who heads municipal portfolio management at Deutsche Bank's DWS Investments, believes the market has unduly punished bonds with longer maturities and bonds slightly down the credit ladder.
By investing for the long term and accepting marginal credit risk, the 58-year-old Boston native believes investors have an opportunity to snap up after-tax returns rivaling those of stocks.
According to Municipal Market Data, the single-A 30-year yielded 5.89% at the close of the market yesterday.
While Condon acknowledges investors probably missed the best time to buy - the rate peaked at 6.94% in mid-December - he said the yield is still enticing based on an array of metrics.
"It's not so much you know what the future is as you know what the past is," Condon said. "The additional yield you're picking up is as high as I've ever seen it ... There's been nothing close to this. It's just unprecedented."
First, the yield overcompensates for owning longer-term munis versus short-term bonds, Condon said.
The 30-year single-A yesterday yielded 342 basis points more than the two-year, according to MMD.
While longer-term bonds usually carry higher yields to compensate for illiquidity and interest-rate risk, Condon said today's discrepancy is too high.
Since the turn of the century, the spread has averaged 210 basis points, according to MMD.
Municipal bonds with longer maturities have suffered during the credit crisis because many of the hedge funds and arbitrageurs that were major buyers of long-term munis earlier this decade had to close shop.
The result was an exodus of buyers from long-term munis. Retail investors, who are the primary buyers of munis these days, typically like intermediate- and short-term munis, Condon said. The liquidity the crossover buyers provided is yet to resurface, he said.
By buying at the long end of the yield curve, investors can pick up bonds at distressed prices and lock in compelling yields for several decades, he said.
The market is also overcompensating for the credit risk of a single-A rating versus a top-notch rating, Condon said.
The 30-year single-A yesterday yielded 87 basis points more than the triple-A, according to MMD. Since the turn of the century, the spread has averaged fewer than 30 basis points.
Condon attributes this to the implosion of the bond insurance industry. Without triple-A bond insurance, a lot more single-A rated bonds are coming to market, which depresses prices, he said.
Plus, during the flight to quality that began last year, investors showed little interest in anything but top-quality paper, Condon said.
Still, the credit risk for a single-A muni is minuscule. The default rate is 0.03% on munis rated single-A by Moody's Investors Service and 0.23% on munis rated single-A by Standard & Poor's.
The shrinking tax receipts and burgeoning budget deficits many state and local governments face are not enough to explain the blowout in spreads, which Condon said has more to do with technical market factors than legitimate credit concerns.
"If you work on the idea that the markets have probably overreacted ... you're in a pretty attractive position," said Condon, who joined DWS in 1983 after working as a fixed-income analyst for CIGNA Corp. and an analyst at the Boston Federal Reserve.
Finally, a common measure of the richness of a muni's yield is to compare it to the yield of a Treasury with the same maturity.
On that basis, the return on a single-A 30-year muni is "off the charts," Condon said.
The single-A 30-year yesterday yielded 165.5% of the 30-year Treasury, according to MMD.
To put that into perspective, until last year it never yielded more than 115% of the Treasury. The yield on the single-A 30-year since the early 1990s has averaged 93.6% of the yield on a Treasury with the same maturity.
