Municipal Bonds: Driven by Individual Investors
Income-seeking retail investors are driving the market for municipal bonds, but a disciplined approach can still uncover opportunities.
Long-dated municipal bonds outperformed Treasurys in the first quarter, and remained attractive relative to investment-grade corporate bonds on a taxableequivalent basis. We expect long Treasury rates will continue to drive tax-exempt municipal bond performance as higher rates beget higher relative value of tax-exempt yields. With a long duration bias, the municipal market is uniquely sensitive to an investor base disproportionately represented by individual investors compared to other fixed-income asset classes. As such, return-chasing behavior commonly found among retail investors has proved a stronger driver of performance than developing trends in credit fundamentals.
Tax-Exempt Municipal Bond Fund Flows Are Linked to Performance
Return-chasing behavior commonly found among retail investors has proved a stronger driver of performance than developing trends in credit fundamentals.
Source: Bloomberg Barclays Municipal Bond Index, Investment Company Institute, Guggenheim Investments. Data as of 3.31.2018. LHS = left hand side, RHS = right hand side.
Primary new-issue supply declined 13 percent year over year, and we expect persistent low supply levels to provide a supportive technical backdrop in 2018 and beyond. Absent a political catalyst, supply expectations for the next few years are constrained by the elimination of advanced refunding bonds and the consequences of supply patterns from the prior decade. We expect softer supply through 2020 due to the 10-year anniversary of the 2009–10 Build America Bond program, which replaced significant portions of long-dated taxexempt bonds that would have been callable and funded by refunding supply.
The Bloomberg Barclays Municipal Bond index posted a 1.1 percent loss in the first quarter of 2018, with longer-maturity bonds significantly underperforming the short-end as rates increased. Losses were fairly evenly distributed by rating, with AAA-rated bonds down 1.2 percent, AA-rated and A-rated bonds down 1.1 percent, and BBB-rated bonds down 1.0 percent for the quarter.
Technical factors will likely continue to dominate the municipal market’s attention, but we emphasize the need to maintain credit discipline, understanding that systemic and idiosyncratic credit risk will be pushed to the forefront in the next recession, which our Macroeconomic Research and Investment Group estimates will begin in late 2019 to mid-2020. We continue to favor higher-quality revenue bonds from issuers that are fundamentally sound on a standalone basis.
Upcoming 10-Year Call Periods of Tax-Exempt Bonds Temper Supply Outlook
We expect persistent low supply levels to provide a supportive technical backdrop in 2018 and beyond. We also expect softer refunding supply through 2020 due to the 10-year anniversary of the 2009–10 Build America Bond program, which replaced significant portions of new money long-dated tax-exempt bonds that would have been callable and refunded.
Source: The Bond Buyer, Guggenheim Investments. Data as of 12.31.2017.
—James Pass, Senior Managing Director; Allen Li, CFA, Managing Director; Michael Park, Vice President
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This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
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