This summary text is fully AI-generated and may therefore contain errors or be incomplete.
In the current market environment, there is an expectation of weak market technicals in the near term, followed by a strengthening in the December-January timeframe. However, before this happens, there is an anticipation of an increase in tax loss harvesting activity, which could add volatility to an already disorderly market.
For selective buyers who are willing to withstand the year-end volatility, there is an opportunity to lock in attractive yields on tax-exempt municipal bonds. The yields currently being offered by high-quality issuers have not been seen in 16 years. This raises the question of whether to buy now or wait until the new year. The recommendation is to seek opportunities to buy highly rated bonds now and become more aggressive in early December before new issue supply decreases.
The yields on short-dated high-quality munis range from about 6.5% to 8% on a taxable equivalent basis. Longer-dated munis offer even more compelling value, with taxable equivalent yields exceeding 10% for taxpayers residing in states with high personal income taxes.
It is expected that US economic growth will slow below trend over the next 12 months. In an environment of slowing economic growth, declining inflation, and looser monetary policy from the Fed, high-quality munis are expected to perform well. However, it is important to note that municipals have higher friction costs and are not as easily traded in smaller block sizes.
For private clients, tax-exempt municipals are best suited for income-oriented investors seeking shelter from higher taxation. It may be worth accepting a short-term unrealized loss in order to secure a portfolio of high-quality bonds for the long term.
The current increase in muni yields presents an opportunity for income-oriented investors to find value in longer-dated munis. The tax-equivalent yields on AA rated high-quality municipal bonds at the 20-year maturity point are currently higher than the average over the past 15 years.
It is recommended to focus on high-quality muni sectors rather than lower-rated high-yield credits. The yield gap between high-yield munis and investment grade munis is currently below its longer-term average, indicating that higher-quality bonds offer better value.
Tax-loss harvesting can be a useful strategy to save taxes. With the increase in muni yields, many individual bonds are now posting unrealized losses. By realizing a capital loss to offset taxable gains, investors can decrease reported investment gains and tax liabilities. However, it is important to consider “wash sale” rules and other portfolio improvement strategies when implementing tax-loss strategies.
Overall, the Chief Investment Officer (CIO) still favors high-quality bonds due to the current market conditions and the potential benefits they offer to income-oriented investors.