Bargains in Munis and Corporates

By Jeffrey R. Kosnett, Senior Editor

From Kiplinger's Personal Finance magazine, December 2008

With the stock market's horrific 2008 results under the microscope, it's easy to overlook the bond market's poor performance. Although Treasuries and other U.S.-government-backed bonds eked out small gains, junk bonds lost more than 20% through mid October; high-grade, long-term corporate IOUs surrendered 19%; and long-maturity, high-quality municipal bonds sank 17%.

Treasuries benefited -- and most other categories suffered -- from flight-to-quality buying. Looking for certitude in a period of deep uncertainty, panicked investors piled into government bonds, forcing up prices and pushing down yields. In mid October, the ten-year Treasury yielded 3.9%, while short-term Treasury bills paid less than 1.0%.

Meantime, consumer prices rose 5.4% over the past 12 months. The inflation rate may drop a bit as commodity prices recede, but "the way the world is printing money since the financial crisis started, I don't see how we can prevent higher inflation" over the long term, says Gregg Fisher, of Gerstein, Fisher & Associates, a New York City investment firm. Fisher says he wouldn't hold any Treasuries longer than four years. Neither should you.

Nor should you plow into junk bonds yet. Many junk-bond mutual funds are sporting double-digit yields. But if the economy enters a deep recession, defaults will rise and prices of junk bonds will fall further.

Instead, as the world's financial system heals, focus on high-grade corporate and muni bonds. Their yields are unusually high because of the fear and confusion in the financial markets. Values of sound bonds are bouncing wildly. A Wal-Mart bond carrying a 6.5% coupon and maturing in 2037 traded for $109 around Labor Day (that means one such bond cost about $1,090). In mid October, the same bond sold for less than $90 and yielded 7.5% to maturity, although Wal-Mart's business is excellent and its bonds are rated AA. Why? Apparently, some traders see a lot of risk in Wal-Mart. We don't.

In munis, it's the same story. Many are paying tax-free yields of more than 5%. An AA-rated Port Authority of New York and New Jersey issue traded for $83 in early October; a few weeks earlier, it changed hands for more than $100. Generous yielders of similar quality are on sale all over America.

NEXT: Are Banks Still Buys?

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