We at Andres Capital have been strong advocates for the municipal market for fundamental and technical reasons throughout 2017. We have made our case in three different articles shown below in reverse order of publication:
- Municipal Bond Portfolio Construction in the Current Environment – August 2017
- The Technical Case for Continuing to Love Municipal Bonds June 2017
- Municipal Volume Plunges as Market Waits for Trump March 2017
- Barclay/Bloomberg Investment Grade Index – (1-2 year maturities) Duration 1.49 years, YTD Return 1.43%
- Barclay/Bloomberg Investment Grade Index – (12-17 year maturities) Duration 6.03 years, YTD Return 5.89
- Barclay/Bloomberg Investment Grade Index – (17- 22 year maturities) Duration 6.20 years, YTD Return 6.03%
On a comparative basis, the Barclays U.S. Aggregate Bond Index provided a YTD return of 3.45% - remember the municipal index returns are federally tax-exempt.
The technical conditions of reduced volume and strong demand, which we called for earlier in the year drove performance. New issue volume was down year over year by 13%, with total issuance through June 30 of $219.7 billion. “New money” issuance increased by 7.0%, while refunding volume declined by more than 25%. Non-traditional buyers, facing negative interest rates in their own markets added to the increase by traditional buyers.
A percentage of individual investors, lacking an understanding of how premium bonds are actually priced continued to purchase par bonds. In doing so, they missed out on the substantial benefits accruing to holders of premiums and subject themselves to the de minimis rule and taxation should the municipal market break down. Professional investors continued to demand 5.0% coupons from borrowers.
The Way We See Things Moving Forward
Municipal securities are not cheap at present levels and it would seem unrealistic to think we can get a repeat of the striking imbalance between July’s 16-year low in supply and the massive reinvestment that took place, which resulted in negative supply of close to $30 billion. We expect continued progress but at a slower pace unless negative conditions develop that engender a flight to quality.
Our bias remains for A-rated essential service bonds with 5.0% coupons. Our yield curve preference continues in the 17 to 22-year sector. We have a negative bias towards most state obligations, particularly those states with egregious pension fund liabilities.
Municipals provide investors with safety of principal, tax-exempt income, low volatility and importantly, a negative correlation to both equities and lower grade corporate bonds. They also act as an anchor to a well-diversified investment portfolio.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.