Municipal Bond Buy Signal?

Our municipal bond momentum gauge has given a buy signal, after turning up from relatively oversold levels and confirming the recent decline in yields from the peak.  At the moment, this is the only major area of fixed income that is both oversold and is also experiencing improving momentum.  You can see the trend in the chart below.

Click to view larger image.

Since 1980, a positive reversal from oversold levels saw muni bond yields fall a median of 43 basis points over the following 12 months.  Of the nine signals over the last 30 years, only two were failures, both in early 1981 when Volcker was trying to aggressively rein in inflation.  So, if you think the Fed is about to begin a momentous tightening campaign, then you should ignore the signal.  Otherwise, municipals look attractive.

Still, if a 78% success rate over 30 years doesn't make you comfortable enough, then a warning sign that a signal would fail is if the momentum were to turn back down.  The direction of momentum is most important for this technical indicator - muni returns are higher (lower) when the indicator is rising (falling).

To view today's complete Market Comment, click here.

Mark Dodson, CFA

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