Long-term interest rates are peaking, making this a good time for aggressive investors to buy bonds, including tax-exempt municipals, according to the chief market strategist at Wheat First Butcher Singer.
"We would buy the higher-grade municipals now versus the lower grade," said Don R. Hays, director of investment strategy at the Richmond, Va., firm.
Hays is forecasting that long-term rates will hover in the 7.50% to 8% range for the next 12 to 18 months. Bonds, including tax-exempts, become a good investment at the current rates, he said.
Last week, Hays altered an asset allocation model for aggressive investors to include a 15% weighting in bonds -- the first time he has recommended any holdings in bonds since Aug. 23 of last year. At that time, Hays called for a 100% weighting in stocks.
John Molster, managing director of municipal bonds at Wheat First, said discount bonds are now cheap and offer good investment opportunities.
"The bonds seem to have the most value in the market right now," Molster said.
"If you're buying for a rally, discount bonds are the place to be."
Discount bonds, sold at prices below par, would be attractive in a rally because as interest rates fall, the price of the bonds would rise quicker than those of current coupon, par, or premium bonds.
Discount bonds are now trading in the secondary market about 10 to 20 basis points cheaper than par bonds, Molster said. Part of the yield disparity is to compensate investors who would face a tax liability if they purchased a discount bond and its price rose, Molster said.
Based on Hays' latest call, Wheat First's mutual fund department has been talking up tax-exempt mutual funds, said John C. Walters, a manageing director of mutual funds at the firm.
Walters said spreads between municipals and Treasuries are expected to widen, which should make municipals even more attractive on a taxequivalent yield basis.
Wheat First does not sponsor its own tax-exempt funds, but its brokers sell municipal funds of several large sponsors.
For investors comfortable with the credit risks of tax-exempts versus U.S. government-backed securities, municipals can be advantageous, Walters said.
"For anyone who's in a tax bracket of 28% or higher, you'd still be getting a better return" with municipals, he said.
Several market strategists said Hays' call on the bond market in the summer of 1993 was prescient.
For the 12-month period ended Sept. 30, the stock market improved by slightly less than 4%, said Rao Chalasani, chief investment strategist at Kemper Securities. The bond market, by contrast, was off roughly 4% during the same period, he said.
"Bonds were the asset not to be in," Chalasani said.
The Kemper strategist said it was too early to tell whether Hays' latest call for a 15% weighting in bonds is on target. He pointed out that bonds are entering their fifth consecutive quarter of declines.
But Peter Van Dyke, president of the Spectrum Fund, an asset allocation bond fund for T. Rowe Price Associates Inc., said, "The potential going forward is better for the bond market than for stocks."
Van Dyke believes that rate increases by the Federal Reserve may soon affect other sectors of the stock market besides the financial services industry. Meanwhile, the bond market, which has long expected a November rate rise by the U.S. central bank, is not likely to fall out of bed if it materializes, the analyst said.