The municipal bond market's correction in June, one of the steepest drops in a decade, has led to an easy decision for investors this summer: buy munis.
After investors pulled $5.4 billion from municipal bond funds in the past four weeks, fearing a slowdown in the Federal Reserve's bond-buying program, some investment advisers say prices have likely bottomed out. That has set the stage for bargain hunting in the summer, a time when good deals usually are hard to find.
(Read More: Muni Bond Strategy Is Buy High (Quality), Sell Low)
"The buffet is full and you can be pretty aggressive with dealers on price," said Michelle Knight, chief economist at Boston-based Silver Bridge Advisors, which oversees about $600 million in municipal bonds. "Normally, at this time of year, you have to hold your nose."
The U.S. municipal bond market has a large base of retail investors, especially wealthy individuals who buy tax-exempt bonds to offset some of their income tax liability.
At face value, a New York muni bond with a 5 percent coupon is throwing off a tax-equivalent yield of 10.1 percent for a Manhattan resident paying the top rate for federal, state and local taxes, research firm Municipal Market Advisors noted in recent commentary.
In the four days after Fed Chairman Ben Bernanke last week said that U.S. growth was strong enough to slow bond purchases later this year, five-year, 10-year, and 30-year municipal yields spiked 43, 56, and 60 basis points, respectively.
On Tuesday, yields on top-quality 30-year bonds were unchanged at 4.13 percent, while the 10-year yields were up one basis point to 2.81 percent. (Yields move inversely to prices.)
"We've definitely brought in a new universe of investors with these higher interest rates," said Tim McGregor, director of municipal fixed income at Northern Trust.
While many muni investors have been battered and bruised this month, there's an army of individuals sitting on huge stockpiles of cash, according to financial advisers.
Eaton Vance in its June commentary said it expected "to continue to see some of this capital flow to munis," adding that the muni market "is also offering a more compelling entry point for those investors who have been patient reinvesting proceeds from (municipal bond) calls, coupons and maturities." There is an estimated $10 trillion in cash and near-cash equivalents in the private sector, according to mutual fund company Eaton Vance.
Yields surged as muni bonds recently experienced a 20-day price decline of 6.84 percent, the second-worst such loss since 2001, according to Municipal Market Advisors.
For those investors already in the market, grinding out rock-bottom yields, reaction to falling prices was swift.
They yanked $2.2 billion from U.S. municipal bond funds during the week ended June 19, an acceleration from outflows of $1.6 billion in the previous week, according to data released by Lipper (a Thomson Reuters unit).
The Invesco High Yield Municipal Fund alone had $302 million in outflows during the most recent one-month period. A number of high yield muni bond funds experienced double-digit declines, led by the $380 million Nuveen California High Yield Municipal Bond Fund's one-month plunge of 10.53 percent, according to Lipper.
"I think people were caught off guard," said Lawrence Glazer, a managing partner at Mayflower Advisors. "There was a high level of complacency going into the Federal Reserve meeting."
Using a standard benchmark measure of comparing the yield of municipal bonds to yields of U.S. treasury bonds, many advisers see plenty of value. Municipal bond yields, for example, on five-year, 10-year and 30-year bonds are 110 percent, 111 percent and 116 percent over respective Treasury bond yields.
"Munis are attractive unless you see another surge in interest rates," Knight, of Silver Bridge Advisors, said. "I don't think the economy would justify another big move."
Robert Lutts, chief investment officer of Cabot Investment Advisers, said there are real indications, though, that a U.S. economic expansion — a catalyst for higher bond yields — could be under way. He cited the strong data on durable goods orders and auto sales.
Still, he described a sizable opportunity for municipal bond investors. "Savvy investors will take advantage," Lutts said.