Although Bank of America Merrill Lynch does not foresee municipals repeating this year’s performance in 2010, the bank’s strategists see a few prominent roles for municipals in their main investment themes for the year.
BofA Merrill’s economists see the global economy surprising investors next year with robust growth. While the International Monetary Fund has forecast global expansion of 3.1%, BofA Merrill foresees growth closer to 4.4%.
BofA Merrill does not see the expansion in output sparking inflation, and expects the Federal Reserve to keep its target for short-term interest rates close to zero throughout 2010.
However, the global expansion will force up long-term rates on bonds as a cheerier outlook for the economy increases demanded returns, BofA Merrill said.
Plus, the debt held by governments in advanced economies is expected to exceed 100% of gross domestic product this year, according to the IMF.
BofA Merrill expects Treasury yields to drift higher as investors grow more concerned about public debt. The company’s fixed-income strategists forecast a 4.25% yield on the 10-year Treasury next year. The 10-year currently yields about 3.5%.
The company forecasts “modestly negative” returns for Treasuries and municipals next year.
That does not mean municipals do not figure into the picture at all.
BofA Merrill issued several recommendations for investment themes in 2010 involving municipals.
Most prominently, the company expects state and local tax rates to jump next year, and the federal tax rate to jump in 2011.
The swelling U.S. budget deficit and the pending health care legislation, plus probably another stimulus package, will have to be financed through higher taxes, BofA Merrill said.
The company recommends investing in general obligation and essential purpose revenue municipal bonds, as well as municipal exchange-traded funds, to position for the increase in taxes.
BofA Merrill also likes certain closed-end funds, including the Nuveen Municipal Value Fund, the Nuveen Premium Income Municipal Fund, and the BlackRock MuniYield Fund.
The company recommends avoiding private-purpose municipal issues.
Because of the rally in the bond market, good buys are hard to find, it said.
From this point on, people should buy bonds for the after-inflation income, not for further price appreciation, according to the company’s report.
The company likes munis in the five-to-15-year range for this purpose.
Municipals have climbed 13.8% so far in 2009, after slipping 4% last year, based on the company’s municipals index.
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