With tax reform up in the air, no-tax or low-tax investments look a whole lot more appealing.
That's part of what's driving the surge in buying in the $3.7 trillion municipal bond market, which saw the largest inflows into mutual funds last week in more than seven years.
"This is the unwinding of the Trump trade or the Trump trade re-do," said Jeff Lipton, head of municipal research and strategy at Oppenheimer. The state and local bonds, in fact, have been outperforming Treasurys since the beginning of the year, with a total return of 2.75 percent, compared with 1.93 percent, he said.
Lipton notes that $1.63 billion went into municipal bond funds for the week ended April 12, the best since October 2009.
Municipal bonds are tax exempt, in that investors do not pay federal taxes on their returns, nor do they pay state income taxes if they buy certain bonds that are exempt in their home localities. The state and local bonds fund everything from schools to bridges and roads to public works projects.
In the days after President Donald Trump was elected, interest rates zipped higher as investors dumped bonds and investors loaded up on stocks. The bet was that there would be a reflation trade from his tax and stimulus programs, and bonds would weaken, with yields moving inversely higher on rising interest rates and inflation.
"Between Nov. 8 and Nov. 29, municipal bonds plunged relative to taxable bonds," said Jack Ablin, CIO of BMO Private Bank. "Since that time, the end of November and by the end of the year, they rallied back to where they were. Now they're holding their own against taxables, which would suggest there's no disadvantage, meaning no tax break."
"The bigger the tax, the bigger the advantage. The smaller the tax, the smaller the advantage," he said. Ablin pointed to the performance of munis in the iShares National Muni Bond ETF versus, which have held their own this year against the taxable bonds in iShares Core U.S. Aggregate Bond ETF.