Intermediate-maturity munis sent a positive signal amid last week's market lethargy, as their prices stabilized at close to fair value relative to Treasuries.
Over the last 12 months, 10-year muni ratios to Treasuries have settled around 98%. Industry analysts consider this level high by historical standards, as the long-term average sits closer to 82%.
But the 10-year actually hovers near today's fair value level, which is between 93% and 95%, John Dillon, chief municipal bond strategist at Morgan Stanley Wealth Management, wrote in a research report.
The 10-year ratio closed Friday at 97%, Municipal Market Data numbers show. By comparison, the 30-year muni ratio, at 112% on Friday, rests above its average for the past 12 months of 101%.
Muni ratios to Treasuries represent the best gauge investors use to determine if munis are appropriately valued. Ratios rise when Treasury yields outperform those of munis and fall when muni yields outperform those of Treasuries.
Last week, munis outperformed Treasuries at all but the long end of the yield curve. Consequently, their value compared with Treasuries improved over the span.
The market had what Dillon referred to as "outsized relative value" when the 10-year ratio stood around 108% during July and August. Subsequent muni outperformance whittled it down, though.
"So, the argument that munis are cheap, at least on a benchmark basis, is really gone away to a degree," Dillon said. "Over the last 30-plus years, 96% is cheap. But in the last two-to-three years, it's really not that compelling."
For another way to regard ratios and fair value, 10-year munis are rich relative to their taxable counterparts, which means that if they revert back to the average for the past 12 months there will be a slight underperformance in this maturity range, said Daniel Berger, a senior market strategist at Thomson Reuters.
A level of parity, or a ratio of 100%, appears to be the market's comfort zone for 10-year ratios, Dillon said. It should remain as such so long as
"The prospect of tax reform is what's going to keep us from getting through 95% on any sustained basis," Dillon said. "What you've seen over the last couple of years, is that the market has had a difficult time sustaining ratios significantly below 95% it will change and revert back to a longer-term ratio relationship once the tax reform shadow is off the table. But that probably won't be for another year or two."
Meanwhile, 30-year munis appear cheap relative to their taxable counterparts, Berger said. This means that investors would see these munis outperform if the ratio reverted back to its average for the past 12 months.
"At the present time, by one measure (looking at the 12-month average), 30-year munis are cheap," Berger wrote. "This is largely due to underperformance versus their taxable counterparts, and there has been no sign that this situation is about to change soon."
