ETFs: Municipal Bonds Find Support With Unusual Cash Inflow

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Gillie

NEW YORK ( ETF Digest) -- Over the past week, volume has been unusually high in iShares S&P National AMT-Free Muni Bonds (MUB). We can't be sure of where the inflow is coming from. If from the sidelines, this is "new" money on confidence in muni bonds. However, if it is flowing out of equities, it could be a safe haven on fears of a market decline. I'm not a tax accountant, but there may also be some tax advantages. Regardless of their reasons or where they are coming from, investors are piling into the muni bond ETF.

According to one well-known analyst, the municipal bond market was going to collapse a year ago. Oops. 

Actually, the very opposite happened. They took off like a rocket ship. Then the pundits claimed they were in a bubble and it was going to burst. Oops, again. The latest fad among analysts is "bubblizing" any sector that goes up on increased volume. As it turns out, municipal bonds are secure, offer a fantastic yield and, using an ETF for exposure, offer an excellent opportunity for capital gains.

There is a word of caution, though. By the nature of ETFs being able to be bought and sold on an intraday basis, they can be sold with the same vigor that they are bought. However, we can see by this ETF, even in market pullbacks, MUB barely flinches. Yield seeking investors tend to hold positions longer term, especially when they've purchased at a yield higher than the percentage of the pullback and have significant capital gains as a "cushion".

 iShares S&P National AMT-Free Muni Bonds (MUB)
is a veritable gold mine for yield and capital gains.


MUB may appear to be weighted in California bonds. However, the top 10 holdings in MUB only comprise 4% of its total composition. It is widely diversified geographically as well as across the various facets of bond issues. With a mere 0.72% monthly volatility, this one won't keep you awake at night worrying about wild swings.

When analyzing a bond ETF, we not only have to analyze it as an equity instrument (on the chart below) but also its associated risk by ratings of its holdings. The rating breakdowns of the holdings are as follows:

AAA - 16.38%
AA - 48.78%
A - 26.62%
BBB - 5.26%
Other - 2.96%

This breakdown reflects 65% of the holdings in MUB are equal or better than the bond rating of the United States. The "Other" category is most likely cash holdings and there are no "junk bonds" in this ETF.

Now lets analyze this position as an equity.

MUB had a recent pullback. The 50-day moving average has proved a reliable support level twice before and appears to be supporting again. Although we haven't seen much price change over the past week, we have had significant volume at this price level showing confidence of investors.

Investor confidence is confirmed at the top of the chart by the reversal in the Money Flow Index. Stochastics plummeted to extreme oversold which, most likely, triggered buy signals on this desirable yielding position.

Further confirmation is the reversal of the histogram on the MACD indicator.

We may not necessarily be assured of another 14% gain as this ETF chalked up over the past year, but even in its worst selloff at the end of 2010, its loss was less than 10%. Furthermore, it shows a potential near term gain of almost 4% to the recent highs of $114.00.

Price support on a pullback, increased yield and reversals of the indicators form an almost ideal buy signal.

The quality of its holdings, a better than 3% dividend and an opportunity for capital gains, makes MUB a desirable position. This is an ideal type of holding to have in an IRA account. Check with your tax accountant to see if there may be additional advantages with dividends on municipal bonds.

Disclosure: At the time I writing, I have no position in MUB.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.