MARKETVIEW
MuniBonds:MakingSenseofthePost-TrumpSlump
December12,2016
4650 Views
Concernsaboutthepresident-elect’staxandfiscalpolicieshavepressuredthe
munimarketinrecentweeks.Butinvestorassessmentsappearoverly
pessimistic.
Af terastrongrunf ormuchof 2016,themunicipalbondmarkethasencounteredsomeheadwinds
inrecentweeks.Theyearstartedwell,andthemarketstillwasabletoweatheranincreasein
interestratesf romtheirJulylowsthroughmid-October.Butthingschangedinthewakeof the
November8thelectionof DonaldTrumpasU.S.president,andRepublicanmajoritiesinboth
housesof theU.S.Congress.ThebroadBloombergBarclaysMunicipalBondIndex,whichwasup
3.1%f ortheyearthroughNovember8,hasf allen3.1%sincethen(throughDecember9),
accordingtoBloomberg.Theshif tininvestorsentimentwasevidentinmuni-bondmutualf undf low
dataf romLipper:Munif unds’streakof 54consecutiveweeksof positiveinf lowsendedinthe
weekendedOctober19,andf lowshaveturnedsharplynegativesincetheelection.
What,exactly,haschanged?Municipalbondinvestorsaredealingwithnumberof concernsrelated
topotentialpolicyinitiativesunderthenewlyelectedU.S.president.InarecentMuniMatters
column,DanSolender,LordAbbettPartner&Directorof MunicipalBonds,exploredkeyf actors
f uelinginvestorconcerns.Amongthem:
PotentialchangestoU.S.taxratesthatmaymaketax-equivalentyieldslessattractive
Theef f ectonmuni-bondsupplyof plannedincreasesininf rastructurespending
Thepotentialf orU.S.stimulustolif tinterestrates,whichcouldhurtlonger-durationmunis
InthisMarketView,we’llattempttoexploretheimplicationsof thesetopicsf ormuni-bond
investors,usingSolender’sanalysisasajumping-of f point.We’llalsoprovidesomecontextf or
muniinvestorswhoareexaminingtheirportf oliosinlightof thesignif icantpolitical,economic,and
markettrendsnowinplay.
Tax-RateChanges
Trumphasf loatedacross-the-boardtaxcutsf orindividualf ilers,includingareductioninthetop
marginaltaxrate,f rom39.6%to33%.Howmightthemunicipalbondmarketreacttolowerincometaxbrackets?Asimilarepisodeintherecentpastmayprovidesomeclues.Solendercitedthe
2000–01period,inwhichRepublicanGeorgeW.Bushwaselectedonaplatf ormthatincluded
reducingtaxrates.During2000,theratioof MunicipalMarketData’s(MMD)‘AAA’ratedmunicipal
bondyieldto30-yearU.S.Treasuriesaveraged96%.Overthesecondhalf of theyear,when
PresidentBushwaselected,theratiostayedaroundanaverageof 96%.In2001,whentaxrates
weref irstlowered,theratiodroppedtoanaverageof 93%duringthef irsthalf of theyear,and
thenmovedtoa94%averageoverthesecondhalf .
“If therehadbeenexcessiveconcernabouttheimpactof lowertaxrates,”Solendernoted,“the
ratiowouldhaverisen,becausemunicipalbondsyieldswouldhaverisenmorethanTreasury
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yields,leadingtounderperf ormance.”Inf act,in2001municipalbondsactuallyoutperformed
Treasurieswhiletaxrateswerefalling.
Whataboutnow?Munisshouldretaintheirappealevenif taxratesareloweredunderaTrump
administration.AsTable1shows,basedonyieldsasof November30,2016,thenominalyields
availableon10-yearmaturitiesof ‘AAA’ratedmunis,aswellasthebroadermunimarket
benchmark,theBloombergBarclaysMunicipalBondIndex(averagecreditratingof ‘AA’),
exceededtheyieldon10-yearU.S.Treasurysecurities—evenbef oreanytaxef f ect.Thetaxequivalentyieldsoneachindexwerehigher,ateachof the43.4%topcurrentbracket(which
includesthe3.8%Medicaretax)andthe33%topratef loatedbyTrump’steam.Evenf orinvestors
inthe28%taxbracket,municipalbondsof f eredattractivetaxableequivalentyieldsversus
comparablematurityTreasuries.
Table1.Munis’Tax-EquivalentYieldRecentlyToppedTreasuriesunderVariousTax
Rates
Source:BloombergandThomsonReutersMunicipalMarketData.BloombergBarclaysIndexdatarepresenta
maturity-specif icsubsetof theBloombergBarclaysMunicipalBondIndex.
Note:Taxratesdepictedrepresentthetopmarginaltaxbracket,43.4%(39.6%incometaxrateand3.8%inMedicare
tax);the33%toprateproposedunderPresident-electTrump’staxref ormplan;andthe28%bracket.Thesetaxrates
donotf actorintheef f ectof AMT(alternativeminimumtax)ortaxesinyourindividualstate.Tax-equivalentyieldwill
varybasedonaninvestor’staxbracket.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentthe
perf ormanceof anyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Lower-ratedbondsmay
carrygreaterrisksthanhigher-ratedbonds.Incomef rommunicipalbondsmaybesubjecttothealternativeminimum
tax.Federal,state,andlocaltaxesmayapply.Indexesareunmanaged,donotref lectthedeductionof f eesand
expenses,andarenotavailablef ordirectinvestment.
Historyalsomayprovidesomeinsightsonthetax-ratequestion.Areportf romCitiResearch
f oundthatbetween1980andDecember2016,thetopmarginaltaxratef ormunicipalshas
f luctuatedintherangeof 28–70%.Yetthereportf oundnocorrelationbetweenmunicipalyields
andthetopmarginaltaxrate.Thisislikelybecausetheaveragetaxratef ormunicipalholdershas
remainedsteadyaround25%duringtheperiodsurveyed.[Resultsmayhavedifferedduring
differentintervalsinthesurveyperiod.]
Muni-BondSupply
Solendersaidanothermajorconcernf ormuniinvestorsishowtheproposedramp-upinU.S
inf rastructurespendingwillbef inanced.Currently,asignif icantportionof theinf rastructureneeds
intheUnitedStatesisf inancedthroughtheissuanceof munibonds.Anyinf rastructureplans
proposedbyTrumpwouldneedtobeapprovedbyCongress;Solenderthinkstheirscopemaybe
reducedgiventhef iscallyconservativeapproachbycongressionalleadershipinrecentyears.
“Withtax-ratereductionslikely,anof f -the-chartamountf orinf rastructurespendingisunlikely,
unlessprojectionsof revenueincreasesarerealizedquickly,”headded.
Still,itisunclearif asignif icantinf rastructure-ledincreaseinmuniissuanceislikely,because
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Trumphasdiscussedmanyotherf ormsof f inancing.“Themostlikelyoutcomeistohavesome
additionalsupplytosupplementotherf ormsof f unding,butnotadramaticincreasethatwould
havealong-termdampeningef f ectonthemarket,”Solenderconcluded.
InterestRates
Sharpinterest-rateincreasesinthepastf ewweeksappeartohavebeenf ueled,inpart,by
perceptionsthatthescopeof f iscalstimulusunderthenewadministrationcouldleadtolarge
increasesineconomicgrowth—andrisinginf lation.Further,thestimulusmightinvolveheavy
issuanceof governmentbonds,atleastinitially,andputupwardpressureonU.S.Treasuryrates.
“Sincemostf ixed-incomemarketsmoveinthesamedirectionasTreasuries,thisalsocouldweigh
onmunicipalbondprices,”Solendersaid.
ButSolendernotedthatthereissloweconomicgrowtharoundtheworld,includinginEuropeand
Japan,withnosignif icantsignsof inf lationonthehorizon;centralbankactionstoboostgrowth
havemetwithlittlesuccess.“Giventhewidespreadof yieldsonU.S.f ixedincometothosein
Europe,itislikelythatwearenotf arf romacaponU.S.rates,”hesaid.“Thepost-electionmarket
reactionintermsof U.S.bondyieldsjustseemslikeitmightbealittletoomuch,toosoonright
now.”Indeed,assomeobservershavenoted,themarketappearstohavepricedanentiref our
yearsof Trumppolicyinonlyaf ewweeks.Inthemain,withglobalyieldsstilllow,U.S.muniyields
appearevenmoreattractiveaf tertherecentmarketaction.
WhatShouldMuniInvestorsFocusonintheCurrentEnvironment?
Af tertakingthef actorsmentionedaboveintoconsideration,wethinkmuni-bondinvestorsshould
notethef ollowing:
1.Wehaveseenthisstorybefore.
Bef oretherecentmarketactivity,therehavebeenthreeperiodsof signif icantoutf lowsin
municipalbondf undsoverthepastsevenyears:November2010–April2011;March–December
2013;andMay–September2015.Chart1showswhathappenedtothreekeymunimarket
benchmarksoneyearaf terthepeakmonthof outf lowsineachperiod.Althoughoutf lows
continuedf orseveralmonthsineachcase,totalreturnswerequitestrongaf teroneyear.
Chart1.MuniBondsHaveProvedResilientafterPastPeriodsofFundOutflows
Historicalinvestmentflowsformunicipal-bondmutualfunds,January2010–November2016
(estimate)(chart);totalreturnforindicatedindexesduringtheoneyearafterthepeakmonthof
outflowsineachcycle(table)
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Source:BloombergandLipper.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentthe
perf ormanceof anyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Indexesareunmanaged,
donotref lectthedeductionof f eesandexpenses,andarenotavailablef ordirectinvestment.
Themunimarket’shistoricalresilienceaf terepisodesof heavyoutf lowsisapointworth
consideringbyinvestorswhohavebeenconcernedbytherecentmarketaction(althoughpast
perf ormanceisnoguaranteeof f utureresults).(SeehowtwoLordAbbettstrategiesfared
undertheseconditions.)Butwhathappensoverthelongerterm?Lookingoverthepastseven
years,whichencompassedallof theoutf lowcyclesmentionedabove,theaverageseven-year
returns,asof December6,2016,f ortheBloombergBarclaysmuniindexeslistedinthetable
adjoiningChart1wouldhavebeen4.0%f ortheMunicipalBondIndex,5.6%f ortheLongMunicipal
BondIndex,and6.5%f ortheHighYieldMunicipalBondIndex.Thebroadtaxablebondmarket,as
representedbytheBloombergBarclaysU.S.AggregateBondIndex,wouldhavereturnedjust
3.5%.
Asyoumayhavef igured,thetotalreturnf orthemuniindexescamef rompredominantlyf romtaxf reeincome.Thelessonhereisthatthosemuniinvestorswhostayedthecourseoverthepast
sevenyearsduringtheintervalsof marketsellingsawsolidperf ormanceintheirportf olios.
2.Thefactorsthathavemademunisattractivearestillinplace.
Inhisarticle,Solendersummedupanumberof positiveattributesof munibondsinthecurrent
market,threeof whichwe’llemphasizehere:
Tax-equivalentyieldsrecentlywereatattractivelevels.
Munishistoricallyhaveweatheredrisingtaxratesratherwell.
ThelargerecentincreaseinU.S.interestratesmaybenearingitsend.
Recentmovesbyinvestorsmightsuggestthat“theyareputtingalargerriskpremiumonthe
marketduetotheuncertaintyof variousscenariosf orthemunisector,”notedSolender,“butitis
possiblethattheymightbeoverlypessimisticaboutf utureoutcomes.”Whenmunicipalbondrates
weremorethanaf ullpercentlowerbackinJuly,therewerelargef lowsintomunicipalbondmutual
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f unds.Butwithtax-equivalentyieldsmuchhighernow,Solenderthinksthatitislikelythataf terthe
currentvolatility,investorswillrecognizethat“theassetclasslooksrelativelyattractive,andthat
outcomesf orthepolicyandeconomicissuesthatkeepthemawakeatnightmightnotbeso
negativeaf terall.”
ANoteaboutRisk:Thevalueof aninvestmentinf ixed-incomesecuritieswillchangeasinterestratesf luctuateand
inresponsetomarketmovements.Asinterestratesf all,thepricesof debtsecuritiestendtorise.Asratesrise,prices
tendtof all.Investinginthebondmarketissubjecttorisks,includingmarket,interestrate,issuer,credit,inf lationrisk,
andliquidityrisk.Themunicipalbondmarketmaybeimpactedbyunf avorablelegislativeorpoliticaldevelopmentsand
adversechangesinthef inancialconditionsof stateandmunicipalissuersorthef ederalgovernmentincaseit
providesf inancialsupporttothemunicipality.Incomef romthemunicipalbondsheldcouldbedeclaredtaxablebecause
of changesintaxlaws.Certainsectorsof themunicipalbondmarkethavespecialrisksthatcanaf f ectthemmore
signif icantlythanthemarketasawhole.Becausemanymunicipalinstrumentsareissuedtof inancesimilarprojects,
conditionsintheseindustriescansignif icantlyaf f ectaninvestment.Incomef rommunicipalbondsmaybesubjectto
thealternativeminimumtax.Federal,stateandlocaltaxesmayapply.InvestmentsinPuertoRicoandotherU.S.
territories,commonwealths,andpossessionsmaybeaf f ectedbylocal,state,andregionalf actors.Thesemay
include,f orexample,economicorpoliticaldevelopments,erosionof thetaxbase,andthepossibilityof credit
problems.
ThisMarketViewmaycontainassumptionsthatare“f orward-lookingstatements,”whicharebasedoncertain
assumptionsof f utureevents.Actualeventsaredif f iculttopredictandmaydif f erf romthoseassumed.Therecanbe
noassurancethatf orward-lookingstatementswillmaterializeorthatactualreturnsorresultswillnotbematerially
dif f erentf romthosedescribedhere.
Thismaterialisprovidedf orgeneralandeducationalpurposesonly.Theexamplesprovidedarehypothetical,aref or
illustrativepurposesonly,andarenotindicativeof anyparticularinvestorsituation.
Thereisnoguaranteethatmarketswillperf orminasimilarmannerundersimilarconditionsinthef uture.
Yieldistheannualinterestreceivedf romabondandistypicallyexpressedasapercentageof thebond'smarket
price.Tax-equivalentyieldisthepretaxyieldthatataxablebondneedstopossessf oritsyieldtobeequaltothatof
atax-f reemunicipalbond.Thiscalculationcanbeusedtof airlycomparetheyieldof atax-f reebondtothatof a
taxablebondinordertoseewhichbondhasahigherapplicableyield.
TheBloombergBarclaysMunicipalBondIndexisarules-based,market-value-weightedindexengineeredf orthe
long-termtax-exemptbondmarket.Theindexisabroadmeasureof themunicipalbondmarketwithmaturitiesof at
leastoneyear.Tobeincludedintheindex,bondsmustberatedinvestment-grade(Baa3/BBB-orhigher)byatleast
twoof thef ollowingratingsagencies:Moody's,Standard&Poor's,Fitch.If onlytwoof thethreeagenciesratethe
security,thelowerratingisusedtodetermineindexeligibility.If onlyoneof thethreeagenciesratesasecurity,the
ratingmustbeinvestment-grade.Bondsmusthaveanoutstandingparvalueof atleast$7millionandbeissuedas
partof atransactionof atleast$75million.Thebondsmustbef ixedrate,haveadated-dateaf terDecember31,
1990,andmustbeatleastoneyearf romtheirmaturitydate.TheBloombergBarclaysMunicipalBond10-Yearand
22+YearIndexesarematurity-specif iccomponentsof theMunicipalBondindex.
TheBloombergBarclaysHighYieldMunicipalBondIndexisanunmanagedindexconsistingof noninvestmentgrade,unratedorbelowBa1bonds.
TheBloombergBarclaysU.S.AggregateBondIndexrepresentssecuritiesthatareSEC-registered,taxable,and
dollardenominated.TheindexcoverstheU.S.investmentgradef ixedratebondmarket,withindexcomponentsf or
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governmentandcorporatesecurities,mortgagepass-throughsecurities,andasset-backedsecurities.Totalreturn
comprisespriceappreciation/depreciationandincomeasapercentageof theoriginalinvestment.
TheMMD10-YearAAAMunicipalIndexcalculatestheyieldon10-yearmaturitiesof AAA-ratedU.S.municipal
securitiesbasedonproprietarydataf romThomsonReutersMunicipalMarketData.
Indexesareunmanaged,donotref lectthedeductionof f eesorexpenses,andarenotavailablef ordirectinvestment.
Thecreditqualityof thesecuritiesinaportf olioisassignedbyanationallyrecognizedstatisticalratingorganization
(NRSRO),suchasStandard&Poor’s,Moody’s,orFitch,asanindicationof anissuer’screditworthiness.Ratings
rangef rom‘AAA’(highest)to‘D’(lowest).Bondsrated‘BBB’oraboveareconsideredinvestmentgrade.Credit
ratings‘BB’andbelowarelower-ratedsecurities(junkbonds).High-yielding,non-investment-gradebonds(junkbonds)
involvehigherrisksthaninvestmentgradebonds.Adverseconditionsmayaf f ecttheissuer’sabilitytopayinterest
andprincipalonthesesecurities.
TheopinionsinMarketViewareasof thedateof publication,aresubjecttochangebasedonsubsequent
developments,andmaynotref lecttheviewsof thef irmasawhole.Thematerialisnotintendedtoberelieduponas
af orecast,research,orinvestmentadvice,isnotarecommendationorof f ertobuyorsellanysecuritiesortoadopt
anyinvestmentstrategy,andisnotintendedtopredictordepicttheperf ormanceof anyinvestment.Readersshould
notassumethatinvestmentsincompanies,securities,sectors,and/ormarketsdescribedwereorwillbeprof itable.
Investinginvolvesrisk,includingpossiblelossof principal.Thisdocumentispreparedbasedontheinf ormationLord
Abbettdeemsreliable;however,LordAbbettdoesnotwarranttheaccuracyandcompletenessof theinf ormation.
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