Munis Top Stocks on Value by the Most in Decades, MacKay Says

MacKay Municipal Managers reports that tax-exempt municipal bonds currently offer compelling value relative to equities, with after-tax muni yields exceeding the S&P 500 earnings yield by approximately 244 basis points. This valuation gap, the widest since 2001-02, highlights a significant opportunity for investors seeking tax-efficient income as equity valuations continue to climb.

Analysis

A report from MacKay Municipal Managers has identified a significant relative value opportunity in tax-exempt municipal bonds when compared to U.S. equities. The analysis reveals that after-tax municipal bond yields are currently exceeding the S&P 500's earnings yield by approximately 244 basis points. This valuation gap is historically notable, representing the widest spread observed between the two asset classes since the 2001-2002 period. The primary driver behind this disparity is the compression of the S&P 500 earnings yield, a direct result of climbing equity valuations, which enhances the appeal of the tax-advantaged income offered by municipal bonds.

Key Decisions for Investors

• Investors, particularly those in higher tax brackets, should consider a tactical allocation towards tax-exempt municipal bonds to capitalize on the historically wide after-tax yield spread relative to equities.
• Given that elevated equity valuations are the primary driver of this disparity, it is prudent to review the risk-reward profile of equity holdings, as their earnings yield is now less competitive against high-quality, tax-advantaged fixed income.
• Portfolio managers should monitor the spread between muni yields and the S&P 500 earnings yield, as a significant narrowing of this 244 basis point gap would signal a shift in the relative value proposition and may warrant an adjustment in asset allocation.