Because Bill Clinton campaigned on a promise to raise taxes on upper-income taxpayers, a Clinton presidency is likely to send those people scurrying for tax shelter. And chances are the nearest one will be an investment in tax-free municipal bonds, or any of the hundreds of municipal bond mutual funds available.
For someone in the current top tax bracket, the after-tax income from a 10-year tax-free municipal bond yielding 5.5 percent is equivalent to a taxable investment paying 7.97 percent. Under President-elect Clinton's proposed new tax structure, with a 36 percent top rate instead of 31 percent, that bond would be equivalent to a taxable one with an 8.59 percent yield, said Robert Ciccarone, director of fixed-income research for Kemper Securities.
But whether an investment in municipal bonds is a safe bet depends on the direction of interest rates. In the weeks before the election, rates crept up, partly on the expectation of a Clinton victory. If interest rates rise sharply in 1993, as some economists think they will, the tax benefit of owning municipal bonds would vanish as they drop in value as interest rates climb.
"I think it's a very dangerous time to be buying municipal bonds," said Don Phillips, publisher of Morning -star Mutual Funds, a Chicago-based fund-rating service. "The prospect of rising interest rates could be a disaster for that market."
But others, including Fidelity Investment's David Murphy, think rates are as high as they'll go in the short term.
"I'm structuring the portfolios to take advantage of further interest rate declines," said Mr. Murphy, who manages four tax-free funds for the giant mutual fund company. He thinks that continuing economic weakness at home and abroad, combined with diminishing exports, will allow room for the Federal Reserve to continue to ease short-term rates.
"I don't see much reason for rates to rise much from here," he said.
Kemper's Mr. Ciccarone also thinks much of the concern that Mr. Clinton's spending policies will increase inflation has been factored into the bond market.
"I don't believe we have a liberal spending mentality in Washington anymore," Mr. Ciccarone said. "Municipal bonds are very good buys right now for all investors."
Tom Conlin, portfolio manager of two municipal bond funds managed by Strong Funds in Menomonee Falls, Wis., is taking a more neutral stance toward the risk that interest rates will rise. He has been shortening the maturity of his funds' holdings to guard against the effect of a sudden interest-rate climb, he said. He will watch carefully to see what economic advisers Mr. Clinton surrounds himself with.
Municipal bonds, free from federal and some state taxes, are most valuable to upper-income earners. Mr. Clinton proposes raising the top marginal tax rate 5 percentage points on couples with income higher than $200,000, providing that group with added incentive to seek shelter.
"Top taxpayers would get the most direct benefit," Mr. Ciccarone said. But middle-income taxpayers also may benefit from owning tax-free bonds, because rising demand among the wealthiest Americans would tend to push up bond prices for all investors, he said.
Another recent factor has made tax-free bonds an attractive buy: Municipalities and local taxing bodies have set a record pace in new issues this year to take advantage of low interest rates.
The heavy supply in the last two months has driven prices down and yields up, making the tax-free bonds something of a bargain for investors willing to take a risk on the direction of interest rates.
"This is probably the best buying opportunity I've seen in the last nine months in this market," said Susan Peabody, senior vice president for Alliance Capital Management's group of municipal income funds. Though prices reflect the current oversupply, she expects them to start to climb with added demand and a slowing of new issues in the next two months.
"What's going to happen between now and year-end is that the value of owning tax-exempt bonds will be recognized. You'll see yields [on bonds with longer maturities] start to come down to the 6 1/2 percent level. With the election outcome determined, demand for municipal bonds will start to go up."
The heavy volume of new issues has been created for the same reason that homeowners have been rushing to refinance mortgages.
When a municipality decides to "call" a bond before its maturity to refinance it, investors are handed back their investment sooner than expected and often look to reinvest in new municipal issues, Ms. Peabody noted.
The next big call date will be Jan. 1, she said, meaning that in
January, "that money will be looking for a new home."